The flood of issuance could push up borrowing costs for companies that are issuing debt to finance takeovers. Other companies could also see their borrowing costs rise, as investors sell their current holdings to make room for new, higher-yielding bonds that are hitting the market.
“Acquisition financing is going to drive the marketplace across the board,” said Richard Zogheb, co-head of capital markets origination for the Americas at Citigroup.
Yields on high-grade corporate debt relative to Treasuries, a measure of how much extra interest investors demand for taking on credit risk, could widen by as much as 0.15 to 0.2 percentage point this year as large deals flood the market, said Joe Mayo, head of credit research at Conning, which manages about $92 billion for insurance companies.
Deal-financing is just one of a slew of factors that could weigh on corporate bonds in 2016, including rising rates and mounting fears among investors that slow growth in the global economy will crimp corporate profits, investors said. In the United States, the Standard & Poor’s 500 index has fallen 5.9 percent so far this year, and ended last week with the worst start for a year on record.
Bond buyers are demanding the largest yield premium over Treasuries in more than three years to hold investment-grade debt, according to Bloomberg indexes. Average corporate bond spreads are now around 1.8 percentage points, up more than 0.6 percentage point from the beginning of last year.
Investment grade companies will probably issue $1.3 trillion of bonds in 2016, similar to 2015 levels, Barclays strategists led by Shobhit Gupta wrote Dec. 18. Acquisition- related issuance will likely account for a higher percentage of that total, which could push spreads wider.
A company’s bond spreads can widen as soon as it announces a large debt-funded deal, as investors fret about the extra financing the company will need. Spreads can also widen just before the new offering as investors sell the issuer’s existing debt to free space for the new, more attractively priced bonds, said Gregory Nassour, principal and co-head of investment-grade portfolio management at Vanguard.
Issuers of the 30-biggest merger-and-acquisition-related bond deals in the past two years saw their bonds perform worse than their peers during the four weeks before they brought M&A-related deals to market and through the date of issue, Barclays strategists led by Ryan Preclaw wrote in a note to clients Dec. 11.
When a company announces an acquisition, its rivals’ bonds may widen too, as investors brace for competitors to follow suit with purchases of their own. That’s a real possibility as companies struggle to boost growth, investors said.
“Boards are pushing the levers of M&A to achieve growth objectives,” said Leo Civitillo, the global co-head of fixed- income capital markets at Morgan Stanley.
Bonds in the tech and oil and gas sectors, which account for the biggest chunk of acquisitions expected to close this year, could see the most widening, analysts and investors said. Wells Fargo is recommending that clients reduce their exposure to companies in sectors that are likely to see more acquisitions, such as technology, where companies have room to add debt and revenue growth is slowing.
If investors’ risk aversion increases, the market could be less willing to absorb big acquisition-linked deals, said Jeff Cucunato, head of U.S. investment-grade credit for BlackRock Inc.
“If markets undergo a bit of turbulence, it could be more challenging for more opportunistic deals to get funded,” Cucunato said.
©2016 Bloomberg News