Moody’s: M&A Props Up Corporate Issuance

A recent surge in merger activity brings the current year’s pace in line with last year’s massive gains. Such heavy dealmaking volume is likely to persist, given favourable capital markets and the desire of firms to gain scale amid weak profit growth. That merger trend can give a great lift to corporate debt issuance, despite earlier expectations for a slowdown in corporate borrowing. Adding to the favourable environment for both issuance and M&A is a highly accommodative global monetary policy that clamps down on interest rates.

M&A uptrends stimulate borrowing
Elevated capital markets volatility restrained the volume of global M&A activity to start this year. Yet with an early March upswing, year-to-date merger volume in Bloomberg figures of $750 billion is right in line with the $749 billion recorded in the same period last year. Though this year’s merger totals may ultimately fall short of 2014’s seven-year high sum of $4.3 trillion, conditions still allow for a very healthy pace of activity. Strong volume in business couplings can filter through to this year’s corporate issuance trends. Right on the heels of the M&A spike, global corporate and financial bond issuance for the yearlong period ending in February reached the five-year high of $3.9 trillion.

M&A is not a prerequisite for strong gains in corporate borrowing, yet it can tie into a late-cycle bulge in debt issuance. When M&A volume reached a record $5.2 trillion for the year ending August 2007, global corporate debt issuance had reached a then-record $3.4 trillion sum in the year ending June 2007. Given the many opportunities issuers have had to refinance their debt at low rates in the past few years, merger related borrowing helps maintain the volume of debt origination.

M&A is rising as a driver of debt issuance
The relative importance of M&A compared to debt refinancing in driving debt issuance is captured in the stated use of proceeds among corporate borrowers. For USD-denominated high yield bond issues for which a specific use of proceeds is stated, 41% cited mergers as at least a partial factor in the first two months of this year. That share is higher than each of the prior 13 quarters, and has come as the need for refinancing has lessened. To date in 2015, 65% of high yield bond issues cited refinancing as one of the factors motivating new lending. That figure is down from the cycle high of 83% reached in Q3 2012. The greater prominence of M&A as an issuance driver has also been seen recently in investment grade debt. In January and February, 27% of investment grade USD-denominated corporate bonds were issued in part for M&A compared to an annual share of 19% in both 2013 and 2014.

US dollar issuance remains robust
Issuance of USD-denominated corporate debt faced particular challenges this year, yet mergers are one factor lifting up dollar borrowing volumes. Year-to-date dollar bond issuance of $439 billion is up 18% year-over-year for a record start. Elevated spreads and expectations of rising interest rates figured to keep dollar debt origination moving backward this year. The latest high yield spread of 478 bp in the Barclays Index stands well above last year’s low of 323 bp. Yet despite the challenges of specific firms such as those in the oil industry, high yield USD bond issuance of $99 billion year-to-date is up 33% year-over-year. Though that growth rate is destined to fizzle out, high yield borrowings may well defy analyst projections for substantial yearly declines. And persistently low rates on the investment grade side can help issuance of high grade dollar bonds to rise comfortably this year. 

Though M&A and debt issuance volumes are interacting favourably, a lack of large-scale leveraged buyout activity is holding back these activities relative to the previous boom. At the time of the 2007 record for M&A volume, LBOs accounted for a large chunk of the total (Figure 4). LBO volume peaked on an annual basis at $1.1 trillion in the year ending July 2007. Currently, LBO volume of $168 billion for the year ending February is just a shadow of its former glory. Several factors are limiting a potential buyout bulge. Regulators are not keen on the club deals of the past cycle that combined the resources of multiple private equity firms. And not only are private equity firms struggling to compete with the resources of large corporate acquirers, there is a reluctance among lenders to finance large LBOs given the last bust. This lack of an extreme LBO boom will cap the upside for new high yield borrowing, yet it can help preserve overall credit quality.

Calmer markets will facilitate deals and issuance
The potential for less market volatility implies smoother sailing for M&A and debt issuance. Initial measures of turbulence in both US credit and equity markets this year significantly exceeded the average levels of 2014. The VIX index of short-term volatility on the S&P stock index has averaged 17.0 year-to-date against 14.1 last year. Showing even more divergence is the MOVE Index of short-term volatility in Treasury bonds and notes, with its year-to-date average of 88.4 well up on last year’s average of 62.0. But now that the Federal Reserve has greatly revised down its projections for the federal funds rate, much credit market uncertainty has been lifted. Though the situation in Greece stands as a notable threat to global financial stability, decent growth prospects elsewhere and accommodative central bankers are encouraging private sector borrowing. Such conditions would keep M&A and corporate debt issuance flowing at a strong pace.

Source: Moody’s Weekly Market Outlook [19^th March 2015]