Blue-chip companies have sold more than $1 trillion of bonds in 2017, passing that milestone for the sixth straight year, as Federal Reserve rate hikes spur companies to borrow while it’s still cheap.
Sales from Amazon.com Inc. and Philip Morris International Inc. helped the corporate bond market reach the $1 trillion mark faster this year than ever before, according to data compiled by Bloomberg. August is traditionally a relatively quiet month, but that hasn’t stopped companies from selling large amounts of debt in recent weeks, including a $17.25 billion deal from British American Tobacco P.L.C.
(Related: Raising Rates: Not So Easy)
Borrowing might grow more expensive as the Fed decides how fast to push up interest rates. The rest of the year will likely be more subdued, according to Dan Mead, head of the U.S. investment-grade syndicate desk at Bank of America Corp., who said last week that companies may be pushing to raise cash now before it gets harder.
“It does feel like we’re stealing some of the latter part of the year’s calendar,” said Mead, who expects issuance in 2017 to be flat or slightly down from last year. “History has proven that at some point you’re going to see volatility return to this marketplace.”
Banks kicked off the third quarter by issuing the most post-earnings debt in at least three years. Then AT&T Inc. came in with a $22.5 billion sale in July, the year’s biggest, followed by an August offering from BAT and Amazon’s $16 billion issue.
Demand from corporate bond investors has been insatiable, especially from overseas money managers fleeing negative or near-zero rates. Investment-grade corporate debt funds have had 11 consecutive weeks of inflows, according to Lipper data.
Bank of America’s Mead said he was surprised that companies have been able to maintain such a strong issuance pace throughout the course of the year. Rising short-term interest rates, uncertainty around potential tax reform and trade wars in a Trump administration all pointed to 2017 putting a stop to six straight years of growing issuance, strategists predicted at the end of last year, with some estimating a 10 to 20% drop in new bond sales this year.
Those factors, in addition to higher equity market prices and better corporate earnings, have suppressed the need to grow through M&A, which has resulted in a lighter mergers and acquisitions calendar, JPMorgan Chase & Co. strategists led by Eric Beinstein said in a report dated Aug. 3. Deal financing has made up 13% of investment-grade issuance this year, down from 20% last year, data compiled by Bloomberg show.
Skeptics are wondering how long the Goldilocks environment can last for bond sales. While demand is still there and the Fed’s pace of tightening has been gradual, investors may not be fully prepared for the rate rises to come, said Henry Peabody, a money manager at Eaton Vance Corp., which oversees around $395 billion in assets.
“The market is underpricing the risk that the Federal Reserve is a little bit more aggressive than the front end is forecasting,” Peabody said.
The other pitfall is fundamental. Investment-grade corporate bonds yielded just 3.11% on average as of Monday, not far from an all-time low, according to Bloomberg Barclays index data. Meanwhile, average leverage ratios, as measured by net debt relative to earnings before interest, taxes, depreciation and amortization, are near their highest since before the crisis for non-financial firms in the S&P 500, according to Bloomberg data.
If you don’t step back, said Gene Tannuzzo, senior portfolio manager at Columbia Threadneedle with $467 billion under management, you might miss something important: “Valuations are very extended.”
—With assistance from Claire Boston.
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