After a solid 2003 for investment grade and a blockbuster showing by high yield, market observers predict 2004 corporate bond issuance will be flat to slightly down, with investors increasingly willing to reach down the credit curve for yield given low rates and improving credit quality.
Investment Grade
Corporate bond officials expect investment-grade issuance to decrease 5-10% from last year's total of $651 billion. "The planets were in alignment with low interest rates and tight corporate spreads all creating very efficient funding for borrowers. It's hard to imagine issuance will be much higher this year," says Jeff Blum , global head of debt syndicate at UBS Securities .
The redemptions and refinancings that drove a lot of last year's issues will play a smaller in 2004's redemption calendar, totaling $329 billion versus $426 billion in 2003 for fixed- and floating-rate debt, according to JP Morgan Securities . "And balance sheet repair will not drive issuance in 2004," predicts Therese Esperdy , head of the investment-grade desk at JP Morgan.
To replace last year's boost from refinancings, officials are hopeful that mergers and acquisitions and increasing capital expenditures will fuel corporate bond issuance this year. If a pick-up in M&A does drive the bond market, the impact will likely be in the second half of the year, notes Blum.
Market observers vary in their forecasts for corporate credit spreads. With the Standard & Poor's Investment Grade Credit Index at 129 basis points, investors have already priced in the good news of 2004 and indicated they expect gradual improvements in credit quality and only a gradual rate increase, says Diane Vazza , head of global fixed income research at Standard & Poor's . "I would be hard pressed to see spreads compress much further," she says.
Others suggest that though spreads will not tighten as much as they did last year, they still have room for improvement. "With the J.P. Morgan U.S. Liquid Index valued at 105 basis points over Treasuries, we believe spreads could rally another 15-20 basis points to 85-90 basis points over Treasuries," says Edward Marrinan , director of North American credit strategy at J.P. Morgan. Marrinan expects that most of the rally, however, will be concentrated in higher-beta sectors, such as media, telecom and autos.
And with cash-rich investors concerned about less supply, the investment-grade market is likely to continue providing funding at attractive levels, capital markets officials say.
"There is a great tailwind in the market for issuers that should last through the first half of the year. After that, it gets harder and harder to predict," says Amery Dunn , head of investment-grade syndicate at Merrill Lynch .
High Yield
The strong momentum from the fourth quarter is likely to extend into the first months of this year. High-yield mutual funds saw $23.7 billion in net inflows in the last three months of 2003. Issuance volume is likely to be down at least 10% from last year's record of $133 billion, according to market observers, though most predict totals well north of $100 billion.
High-yield refinancing will continue as borrowers scramble to the market in anticipation of rising rates, but it will be a significantly lower percentage of total issuance, closer to the 50% historical average rather than last year's 75%, says Tim O'Hara , head of high yield capital markets at Credit Suisse First Boston .
Capital markets officials are hopeful that increased M&A and sponsor activity will drive the high yield market in 2004. Sponsor related deals in 2003 from Dex Media , HM Publishing , and the recently announced sale of Warner Music bodes well for 2004 activity. However, "we're not sure that snapshot [of sponsor activity] becomes a movie yet," cautions O'Hara.
Bankers predict that issuance will be broadly based across industry sectors, deal sizes and structures as investors focus on yield. Riskier credits and structures--such as the dividend recapitalizations that raise proceeds to fund equity sponsor dividends--will continue to be acceptable to investors, bankers say.
The Standard & Poor's Speculative Grade Credit Index finished last year at 457 basis points over comparable Treasuries, a 44% tightening for the year. But optimism regarding this year's credit spreads continues to abound. "Current spreads may be tight relative to historical levels. However, given that we believe we are at the early stages of a multi-year credit up cycle, the appropriate comparison would be to the 1992 to mid-1998 period when spreads were consistently in the 300 - 500 basis points range," says Melissa Weiler , managing director and portfolio manager at Trust Company of the West .
2004 Redemption Calendar (in blns)
FIXED-RATE FLOATING RATE TOTAL
Q1 54.2 37.4 91.6
Q2 59.1 32.7 91.8
Q3 63.9 24.3 88.2
Q4 37.6 19.6 57.2
Total 214.8 114.0 328.8