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Massive interest rate hikes triggered by inflationary pressures as well as supply and demand imbalances made 2022 especially challenging for global bond markets. Will 2023 bring more of the same turbulence? On this episode of Market Points, you’ll hear from Patrick Dabiet, Managing Director and Head, Canadian Debt Syndication, and Fadi Attia, Managing Director and Head, U.S. Debt Syndication.
They’ll discuss key themes from the Canadian and U.S. markets in 2022 and why there may be reason for optimism for the upcoming year as it relates to corporate bond issuance patterns. Let's get started. Here’s Patrick Dabiet.
Patrick Dabiet: Fadi, thanks for joining me today. Looking forward to sharing our insights on the market in 2023.
Fadi Attia: My pleasure. Look forward to digging deeper into this.
PD: So Fadi, in Canada, 2022 was the second busiest year of all time from a volume perspective. But certainly, how that played out was a little bit abnormal from the cadence of issuance. So, we saw a record Q1 for volumes followed by really a dearth of supply for nearly the entire rest of the year. We had tremendous supply surges at various points of the year, and I think it’s really interesting to sort of note that 50% of all issuance last year came on just 10% of the business days. So that really demonstrates how supply really came in such a concentrated amount of time. I think the other key element in terms of how the supply picture played out last year was just the sheer amount of volume that we saw from the Big Six Canadian banks, or the DSIB, as we refer to them as. They really contributed an outsized amount of supply. Roughly 50% of all supply came from those six borrowers in Canada, setting records in terms of the amount of issuance we saw from them. But when I think you take a step back and you look at how borrowers responded, it was a very different picture between various parts of the market. I think, for one, there was a large cohort of issuers that were not represented at all. In fact, it was nearly a third of all borrowers in our market did not do any funding last year at all, and that’s a function of the volatility and the sheer fact that they had other liquidity sources that they were leaning on to weather the volatility that was prevailing in the market in 2022. For the remaining two thirds that did come to market, we did see some borrowers look at issuing on the short end of the curve, while others elected to take more of a long-term pragmatic view and issue in the long end of the curve. So, I think that that’s notable. But overwhelmingly, I think we saw a more simplified funding approach from corporate borrowers. So, M&A transactions reverted back to their historical average of about three transactions last year. We saw a significant decline in the number of inaugural borrowers. We saw four as opposed to sixteen in the prior year. And when you think about jumbo transactions in the Canadian market which is roughly $2 billion plus context, we saw three such offerings of that nature last year versus nine in 2021.
So, I think you saw a much more simplified approach from those borrowers that were tapping the market in light of the volatility. But what are you seeing on your side, Fadi?
FA: So, Patrick 2022 was fairly similar in terms of being an abnormal issuance year here in the U.S. I’m going to break it down into six different segments that drive our markets in the United States. Rates has been a very big theme throughout 2022. We’ve seen a significant amount of pressure build up across the rate curve. So, as you look at the U.S. treasuries, whether it’s the front end or the back end, we’ve seen a significant move higher in rates. So, the segment of the market being the most liquid has drifted higher by 182 basis points throughout the course of 2022. And this was driven mostly by the Fed’s aggressive approach from a monetary tightening perspective. So, the Fed ended up hiking rates by 425 basis points in 2022. The most in any given year since 1980.
PD: Wow. That is historic for sure.
FA: And as a result, the IG issuance volumes were impacted meaningfully by these rate hikes and the volatility that ensued on the back of that, where we saw total volumes drop by 18% in 2022 versus the previous year. And the composition of that new issue volume was different versus previous years as financials accounted for an elevated 63% of that total supply, meaningfully higher than the 50% average that we’ve witnessed over the past five years.
PD: Okay. So that's interesting. That’s effectively in line with what we saw on the Canadian side where financials dominated the supply picture in 2022. What do you think was driving that?
FA: Well, I think corporate borrowers pulling back their bond issuance volumes given the rising cost of funding. Which was driven by spreads migrating higher, rates moving higher, and that effectively putting corporate borrowers on the sidelines until this dynamic started to normalize. Tenors was also a slightly different breakdown in terms of the new issue calendar for us here in the U.S. We’ve seen a spike in short-dated issuances that was driven by investors looking to shorten duration in their funds and also issuers not looking to lock in long-term funding given the elevated funding costs. M&A, very big theme in our markets in the United States that typically tends to be a very visible component of volumes and historically averaged about 19% on a three-year basis, decreased to 9% in 2022. So, a meaningful drop in M&A funded activity in the bond market and that was naturally impacted by the uncertain economic outlook, which slowed down the consolidation and M&A activity globally and in the United States. And finally, ESG, huge theme in the U.S. which continues to build out and play in a very visible manner, but also was equally impacted from a volume perspective. Merely registered $77 billion in 2022, which was close to 20% below previous years.
So, Patrick, ultimately the question is, do we see a more balanced or normal 2023 from a composition perspective? What are your thoughts about Canada?
PD: Yeah, so I think for this year we’re looking at volumes to come down more in a historical average. So, we’re looking for $117.5 billion, which will be down 6% from, again, the second busiest year of all time in 2022. I think the big driver of that is going to be financial or DSIB specifically, which is going to be 35% lower year-over-year. Again, just sort of mean reversion from that record year last year. And on the corporate side, we do expect a little bit more of a normalized representation from the corporate issuer base where we expect them to be roughly 40% of overall issuance this year, again, more in line with the pre-pandemic average. But I think there’s still a big question mark as it relates to how corporates are going to respond in 2023. I think a significant focus on the cost of borrowing, which I know is a huge driver of sentiment and behaviour among corporate borrowers last year. But it’s also going to be dependent on the specific issuer’s view on the economic outlook and whether or not the interest rate market and interest rate volatility is going to perhaps keep funding needs, whether it be M&A or CapEx or growth initiatives, more in check than in years past where all-in rates have been more favorable to borrowers to lock in those rates. So, I think that’s still a big question mark as it relates to volumes in 2023. And I think we’re going to have to wait a little bit to get a little bit more of a better sense in terms of how the corporate market is going to respond.
But what about for you, Fadi? In 2023, what are you looking for from a U.S. new issue volume perspective?
FA: So, we think the similar story is likely to unfold in the U.S. There’ll be some variations which are unique to the U.S. market based on the variations between the two markets. But, you know, if we start off with macro, we’re starting to see inflations show signs of slowing down. And the Fed is getting closer to its peak side of the hiking cycle. Rate forecasts for the 10 Year U.S. Treasury are starting to stabilize and exhibiting less volatility so far this year. And as we reference Scotia’s Economists’ ten-year forecasts, they’re calling for the first quarter on the 10 Year Treasury to reach 3.25% and to finalize the year at 3.45%. We think that’s going to be positive for credit. We think that the rate volatility normalizing and the hiking cycle winding down, 2023 is likely to be a much more actionable year for issuers and be offering more stable windows of execution. And that can translate into lower New issue concessions and better secondary performance on the follow-up. We also think that that should be positive for investment grade credit spreads, meaning that credit spreads should compress barring a deep, prolonged recession. We think that spreads are probably going to be rangebound initially during the course of the first quarter of 2023, but they’re likely to be very reactive and dynamic to economic releases and the projected earnings outlook for the balance of the year as the market tries to interpolate what the economic picture is going to look like for the duration of this year. We think issuance volumes are likely to be in line with the 2022 total at $1.25 trillion, corporate issuance is forecasted to be 45% of the annual volume, which is 10% higher than 2022. And that’s going to be helped by more attractive cost of funding for the corporate borrowers. We do expect a significant amount of this borrowing to be frontloaded during the first half of 2023, where a lot of immaturities, which are $635 billion for the full year, 60% of that is maturing during the first half. And the improvement in market tone is likely to encourage issuers to de-risk a significant portion of that refinancing early on, during the early part of the year and effectively take advantage of the prevailing market conditions, which can be positive. We also expect M&A to be slightly more normalized, but we’ll continue to be very much a function of how the economy trajectory plays out. In a soft landing scenario, meaning that if the recession is shallow or short lived, we expect M&A to drift back towards the normal averages over the previous years, which would be around 15% to 20% of total new issue supply. And in a hard landing scenario, where a recession is deeper and or long lasting, we estimate M&A volumes to remain muted and be 5% to 10% of total volume. And then finally, ESG and label issuances are expected to rebound from 2022. A few factors there will help that rebound. The Inflation Reduction Act in the U.S. is likely to be supportive. The continued focus on ESG regulation is going to be a big driver in supporting that market and the continuation of the energy transition, which is a big focus area for that sector.
PD: So, sounds like conditions are improving that should give corporate borrowers a little bit more of a stable platform to take advantage of in 2023. But perhaps still a few unknowns as it relates to whether or not those corporate borrowers are actually going to be in a position to want to take advantage of those conditions.
But I think that’s probably a good chance for us to talk a little bit about the investor sentiment, as we’ve seen over the last few weeks and months, as we re-accustom ourselves to a higher rate inflation environment. But what are you seeing on the U.S. side, Fadi?
FA: Right. So, I think bond investor sentiment will continue to be very much driven by the general market volatility. I think volatility will continue to be a big, big mover influencing investor sentiment. We do think that the attractive valuations currently on offer in the credit markets, certainly relative to other risk asset classes, is going to anchor a historically outsized amount of liquidity towards the investment grade corporate issuance calendar supported by attractive total return on a historic basis. This year has already kicked off well, if you look at the January investment grade, total returns, it’s already above 3.5%, which is going to further underscore and anchor the strong investor appetite for bonds. And we think that will help bring down the borrowing costs for issuers through better, healthier secondary market performance. The 10 Year part of the curve is going to continue to be the core funding access point for many issuers because it’s anchored by the deepest pockets of liquidity on the investor side. And that's going to continue to offer the most assured execution outcome for most borrowers. And then complementing the 10 Year, the investor demand for short-dated issuances is going to remain elevated, certainly versus historic portions or volumes or amounts, and that’s going to allow issuers to remain nimble and flexible and be able to de-risk a portion of their financing and funding needs in a way where it helps them bridge to a better market if that theme and the trend continues over the next few years.
Can you speak to the Canadian side, Pat, in terms of what you’re seeing on that side?
PD: Yeah. So, I think you touched upon a couple of really salient points. First and foremost, returns year-to-date, I think are going to be a tremendous platform for the fixed income asset class as a whole, especially as we head into retirement savings season for most retail investors, both in Canada and in the U.S. So, I think putting aside the very, very weak returns for the asset class last year, I think it’s all obviously a function of the rate market and what that ultimately did to the asset class. But I think we’re certainly seeing green shoots as it relates to investor sentiment and activity towards the tail end of 2022, and that certainly played out in the first month of the year so far into 2023. Our conversations with investors have been very constructive. I think for the first time in several months we’ve seen consensus among most investors that they, A) have cash to put to work, and B) are actively looking to deploy that in the market. And I think that’s a function of the core tenant of fixed income in that for the first time in several years, it actually offers an attractive yield plus capital preservation. And in an uncertain economic world and reality that we’re all living through, I think that is a very enticing investment proposition for a lot of investors to be looking at. So, from an access point, I think that sets the market up exceptionally well for 2023, in terms of the access to market. I’m not going to go ahead and say that these conditions are going to prevail for the balance of the year, because I do think that there’s still a tremendous amount to be written still about the inflation and the interest rate story that I think is going to continue to play out in the coming weeks and months. But certainly, from what we’ve seen thus far, it’s been very constructive and we are encouraged by the early signs of investor engagement in 2023.
So, I think that probably leads us to the last point that we want to raise and discuss here today Fadi, and that is what are the key themes for issuers to navigate around in 2023? How can issuers expect to take advantage of some of these opportunities that we’re seeing emerge in the market?
FA: Right. And I agree with your sentiment, Pat. I do think in the U.S. for issuers, there’s a few factors that are going to be key and critical from a new issue perspective and an execution perspective. Issuers will be better served by accessing the market opportunistically to lock competitive funding. And what I mean by opportunistically is effectively laying out a strategy and a long enough timeline to be able to pick the right windows from an execution perspective. To your point, volatility is likely to persist in the background, and I think that strategy will be helpful as it makes a big, big difference in terms of the execution outcome and the clearing cost for most borrowers in our markets. The uncertainty around the spread and the rate outlook can be also mitigated to a certain extent by funding across a variety of different maturities. To be able to blend down the cost and smooth out the refinancing profile for these borrowers, rather than clustering the financing into a narrower selection of maturities. And equally important, investor engagement will continue to be critical, whether that’s through marketing deal or non-deal related approaches, rationalizing the issuance program. All of these investor touchpoints are likely to drive execution efficiencies for these borrowers and help alleviate concerns that can impact borrowing cost.
PD: Mmm hmm. Very interesting. Well, I think look, a lot of similar themes in Canada here, Fadi. So, as it relates to accessing the market, I think what’s clear for this year and what we saw last year is that the economic calendar has been harder than ever to navigate for corporate borrowers. I think you’ve got not only focus on central bank decisions, employment reports, but you’ve got inflation prints and in the U.S. you’ve got both PCE and CPI reports to contend with. So, I think that's been a function as to why you saw such concentrated amount of issuance in terms of number of days last year, that’s likely to prevail. So, I think having that nimble or opportunistic approach that you were speaking about is really going to be a continued theme as it relates to our advice to corporate borrowers that are looking at the market.
I think one facet of the Canadian market that does bode well, at least from a global perspective that is unique, is it does allow issuers the flexibility in terms of finding an approach to market that best suits the prevailing market conditions. So, if conditions are exceptionally buoyant, we can outline a path to market that expedites your time in market and takes advantage of those strong conditions. If we do see a little bit more choppiness and volatility re-emerge, we do have the ability to, as you mentioned, engage with investors to feel out the investor base as it relates to their appetite from a depth and pricing perspective without needing to actually follow through with the transaction. And that allows you the opportunity to monitor the market and find those pockets of stability that give you the best execution for your potential bond transaction. So, I do think that that’s a very interesting component of the Canadian market that is unique on a global perspective. And again, I think just to reiterate, I think what we’re hearing from the investor base is a tremendous amount of desire and hunger for new names and investment opportunities. So, I think to conclude on our side, we feel quite encouraged and we're hopeful that 2023 continues on that path.
FA: I agree with that, Pat. We’re cautiously optimistic on our outlook here in the U.S. We do believe that the market will offer marginally better opportunities for issuers and investors throughout this year in comparison to 2022. And we do think that there will be a number of dynamic factors that will influence the outlook for which the market will have to work through to ultimately get to a point where issue execution starts to deliver on a better basis for the market.
PD: Yeah, that’s right, Fadi. So again, we’re seeing some green shoots, but we’re not necessarily seeing things in full bloom yet. So, we’ll see how things play out in 2023.
FA: Pat, thank you for chatting today.
PD: Thanks for your insights as well.
FA: For our listeners and our clients who are looking for a more detailed issuance forecast, you certainly can reach out to us in the corporate bond syndication groups across Canada and the U.S. 2023 is definitely going to be an interesting year in the debt capital markets.
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