Corporate credit markets do brisk business with Fed help

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It appears that the great corporate credit crunch of the coronavirus recession has been averted—for now.

Two weeks after the Federal Reserve announced a historic series of measures designed to pump much-needed liquidity into the corporate bond markets, the moves appear to be having their desired effect. Companies in need of cash to sustain operations during what’s sure to be a brutal economic period are now issuing new debt at a prolific pace—provided they have sufficient, investment-grade credit ratings.

Last week, U.S. investment-rated companies issued $113 billion in notes—an all-time record that just edged out the previous mark set one week earlier, according to S&P Global Market Intelligence. The likes of Oracle, T-Mobile, and Nike were among the companies to tap the market, which has been buoyed by the Fed’s launch of two corporate credit facilities designed to buy hundreds of billions’ worth of investment-grade debt in both the primary and secondary markets.

With the knowledge that the Fed is effectively functioning as a backstop for the corporate credit market, lenders have been willing to turn on the spigot and provide companies with the funding they need to ride out the rough economic conditions that await.

“To say there’s been an increase in corporate bond issuances is an understatement,” said Charles Schwab fixed-income strategist Collin Martin. “In the last two weeks, the amount of investment-grade issuances have escalated through the roof. Companies have issued debt once they could, to ensure they have cash to deal with [economic headwinds].”

While corporate credit spreads relative to U.S. Treasuries have widened in recent weeks, Martin notes that many investment-grade companies are still able to issue debt at “historically low” interest rates.

“If you’re a company and you can issue debt at a yield of 3.5% to 4%, that’s still historically low,” he said. “The [economic] outlook is so uncertain, so if they’re able to issue debt at what are still low yields to help ride out this storm, I think we’ll continue to see that.”

Of course, not all companies hold investment-grade credit ratings; in fact, the economic impact of the coronavirus lockdown has prompted a wave of downgrades that have seen some companies brought down to speculative, “junk” status on the back of cash flow concerns. With more than half of all investment-grade bonds rated just above junk territory, some observers have expressed wariness over what deteriorating credit profiles could mean for a huge swath of companies in need of financing (or refinancing) in the midst of a recession.

“The problem is going to be with those companies that are rated below investment-grade,” said Mayra Rodriguez Valladares of capital markets consultancy MRV Associates. “If any of those companies need to open up new lines of credit as this [downturn] intensifies, they’re going to have a hard time.”

“Not a normal recession”

Unlike investment-grade notes, the Fed’s newly launched corporate credit facilities don’t target speculative-grade, high-yield bonds. (And many of the world’s biggest pension funds, by rule, must stay clear of these riskier bets.) While some junk-rated companies have issued new bonds as of late—fast-food conglomerate Yum Brands sealed a $600 million raise last week, for example—market conditions have proven more difficult for companies on the lower end of the credit spectrum; the leveraged loan market, for instance, saw no new deals launched in March for the first time since December 2008, according to S&P Global Market Intelligence.

For many companies with shakier balance sheets and credit profiles, it is the abrupt, severe nature of the current economic slowdown that will pose a significant challenge, according to Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management.

“The reality is that we’re going through a sudden-stop recession,” Shalett said. She estimates that “roughly 30% of the economy is going to put up literal zeroes in revenue for the [second] quarter” as a result of the coronavirus lockdown. “That’s not a normal recession. The economic pain of this remains to be seen.”

One positive of that dynamic, according to Shalett, is the potential for the economy to “snap back to some level approaching full utilization” by autumn, should the pandemic pass and the lockdown be lifted. “This recession is very different; it’s not a business cycle recession, it’s a man-made, behavioral recession,” she noted. “You usually see the train wreck evolve over 18 to 36 months; this time, we’ve seen the train wreck evolve over four weeks.”

As such, she gives it “at least 50-50 odds” that the coronavirus recession is “reasonably short-lived”—which means there are opportunities for investors to take advantage of a pullback in some areas of the market, including underperforming corporate debt. “Do we think a lot of businesses are going to come back? Yeah, they will,” she added.

Likewise, Martin notes that Charles Schwab recently lifted its guidance on high-yield corporate bonds, on which it had been underweight since mid-2019, on the thesis that investors may find value. “You can hold them if you’re a long-term investor and willing to ride out the volatility, because we do still think it’s going to be volatile,” he said. “We do think we’ll see a lot of corporate defaults.”

Because for all the historic moves pursued by the central bank, the fact remains that the Fed can’t “wave a magic wand and make [companies] profitable,” Martin noted. “If profits continue to deteriorate, we’ll likely see downgrades continue.”