Supply in the investment-grade credit market in March has come at a dizzying pace. Non-financial issuance for the month was $190 billion, compared to the March monthly average of the past five years of about $70 billion.
This is in glaring comparison to the state of the primary market during the 2008 – 2009 global financial crisis. Using September 2008 as a data point, primary markets were all but closed, with some $15 billion in non-financial issuance during the month. Notably the current crisis is not one originating from the financial system and importantly the Federal Reserve’s policy response has been much quicker, including new programs that directly support investment-grade corporate borrowers.
Non-Financial Primary Market Issuance
Source: Bloomberg Barclays, exclude financials.
Specifically, the game-changer has been Fed support in the form of purchasing programs for corporate bonds through the Primary Market Corporate Credit Facility (PMCCF) and the Secondary Market Corporate Credit Facility (SMCCF). The PMCCF and SMCCF add two additional buyers to the already global swath of investors in U.S. dollar-denominated investment grade credit. Under the PMCCF, investment grade companies can issue directly into the Fed, removing near-term liquidity risk via a lender of last resort.
Under the SMCC, securities with maturities of five years or less are eligible for up to 10% of total outstanding bonds per issuer. While not initially excluded, financial issuances are unlikely to be purchased by the Fed, in our view, replicating the policy of the European Central Bank. The two programs seek to act as a backstop for the market, to provide direct financing to companies and support liquidity in the front-end.
The Healing Process
In our opinion, these credit facilities have and should continue to guide the healing process for investment-grade credit markets, largely addressing the liquidity concerns caused by the blow-out in front-end spreads in the secondary market. Evidence of this is already visible in the rally in credit spreads over the past week, and most astoundingly recognized by the collapse in average new-issue concessions, which declined from about 60 basis points to essentially zero week-over-week. The Fed’s facilities specifically address investment grade over lower-rated segments of the fixed income universe, notably providing a platform for potential investment grade outperformance in the consequently lower-yield environment that we expect to find ourselves in globally as a result of COVID-19.
Looking at supply over the past few weeks, given this backdrop, use of proceeds was generally to bolster liquidity or refinance upcoming maturities given the plethora of unknowns in the market. Supply was represented overwhelmingly by high-quality issuers, with single- and double-A rated companies accounting for a large portion of issuance. Several of the issuers, while well capitalized, may be be materially impacted by COVID-19 from topline, profitability and cash flow perspectives, and likely wanted to bolster liquidity in the face of uncertain operating conditions over the next several months.
As the market has stabilized and waded through the details of both the Fed’s SMCCF and PMCCF programs, demand for new issue paper has remained extremely robust, with most issuances in excess of 10 times oversubscribed despite the aforementioned collapse in new issue discounts. Short-term performance has also been strong, with deals continuing to rally after pricing. In the first few weeks of the selloff, when concessions were at their peak, non-traditional buyers with distressed, high yield and even equity capital were involved in the investment grade market. These investments generally paid off, with some securities up 30 points in just five trading days.
While the key technical driver over the past week has been monetary support, we cannot ignore the fiscal stimulus response that was finalized this past Friday. The recently passed Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) will provide support to impacted workers, small businesses and large essential impacted industries such as airlines. Over time, these efforts should provide some stability to the uncertain operating environment that companies are currently trying to navigate.
While most of the new issuance has come from high-quality, well-capitalized investment grade names, we recognize that issuing debt to bolster liquidity today could end up meaning increase leverage in the coming quarters, depending on how the operating environment evolves during the time of COVID-19. Management team and board behavior will be a key determinant as it relates to use of proceeds and the ultimate impact on corporate balance sheets. While central bank support is important, discriminating credit selection will remain crucial.
It’s likely the COVID-19 headlines are far from over, and investment grade credit, like other parts of the fixed income universe, will be dealing with the fallout for some time. However, it’s also likely that the policy responses, both monetary and fiscal, have reduced the likelihood of tail outcomes for the both market and the economy.