Market Participants Expect Pickup in High-Yield Issuance in 2024; 2023 Volumes Up 50% on 2022

A rise in new high-yield bond issuance this year has offered market participants hope for next year’s primary market activity.

New U.S. high-yield bond volume increased this year, with over $160 billion pricing in 225 deals as of Nov. 30, compared with last year’s $103.5 billion in 142 deals, amid a grim market. The uptick bodes well for the coming year - market participants expect new dealmaking to continue to thrive as issuers look to tackle debt maturities due in 2025 and 2026.

To be sure, there is not at this point a monstrous overhang of maturities, as many companies pre-funded during the zero-rate Covid-19 period, kicking maturities further out. Still, about $47 billion of high-yield bonds matures next year, while $130 billion matures in 2025, according to an MUFG Bank report. Issuance in 2024 will be driven primarily by refinancings, market participants say.

“The supply picture this year has been relatively anemic,” said Ben Burton, head of leveraged finance syndicate at Barclays. “Volumes for 2024 will likely increase due to significant marketwide upcoming maturities that need to be extended.”

Following a year in which 10-year yields hit 5%, the highest since 2007, easing pricing pressures and a stable unemployment rate in 2023 point to moderating growth and an environment in which the Federal Reserve could cut rates in 2024.

High-Yield Activity Amid High Interest Rates, Maturity Wall Looms

An “anemic” supply is a result of a majority of transactions in 2023 being opportunistic refinancing that only recycles capital, rather than adds money to the marketplace, creating a basic incongruence between supply and demand. Refinancing has accounted for roughly 67% of high-yield activity in 2023, compared with 45% in 2022, according to Reorg data.

High-yield volume by use of proceeds through Monday, Dec. 4, is shown in the chart below:
  Burton said that he expects supply in 2024 to be driven primarily by refinancing activity as well, noting that event-driven financing will remain episodic until there is a sustained increase in M&A activity. Still, as maturity walls creep closer, issuers have begun to accept the grim reality that they will have to refinance their debt at higher rates than before.

Peter Tchir, head of macro strategy at Academy Securities, however, remains optimistic about the market climate, noting that despite the threat high interest rates pose to pricey refinances, there is still ample time to plan and take advantage of stabilizing market conditions.

“I’m not worried right now,” Tchir said about issuers’ ability to address debt maturities. He added that he seeks opportunities among issuers facing significant near-term maturities. Tchir predicts that bond issuance will pick up as market participants start addressing their debt maturities.

In addition, data predicts that the Fed may be willing to accept inflation of higher than its 2% target. CME Group data indicated a roughly 60% chance that the Fed will lower rates by a quarter of a percentage point by its May 2024 policy meeting and implied that there will be four cuts by the end of the year.

The Fed’s next interest rate decision comes on Dec. 13, when rates are likely to remain unchanged at 5.25% to 5.5%.

Tumultuous 10-Year Treasury Depends on Whom You Talk to

Though the 10-year Treasury rate has risen as much as 160 bps since mid-May, its rocket-ship rise was years in the making, beginning with the 2009 financial crises, quantitative easing that lasted just shy of a decade, downgrades of the U.S. credit rating, then Covid-19 stimulus and post-Covid-19 quantitative tightening.

“A 5% Treasury isn’t actually that high when you view it in the larger historical context,” said Victor Drapala, professor at New York University School of Professional Studies’ division of programs in business and retired supervising risk management specialist of the New York State Department of Financial Services.

What is more striking, Drapala noted, is the high level of Treasury issuance for the coming years.

“We’re going to get more Treasurys than ever dreamed of going into election year,” said Drapala. “That’s going to pressure Treasury rates, and I think the Treasury market is setting itself up to be disappointed.”

Tchir also opined that he views Treasurys as “safe” but not nearly as “safe” as they were a year or two ago. He noted that yields may be decreasing now for many of the wrong reasons, such as supply and deficit issues and a weakening economy.

M&A Transitions

Before the recent increase in interest rates, private equity firms for many years enjoyed the nearly zero cost of capital when constructing new merger and acquisition deals. Now as the cost of borrowing has ratcheted up, the market for M&A has shifted.

“Businesses that are out there for 2024 aren’t the quality businesses,” said Matthew T. Simpson, co-chair of private equity practice at Mintz. “The real quality assets are still trading, but if you’re going after high quality, you really have to pay up, be banked and buy more equity than debt.”

As a result, Simpson said that firms are pivoting to focus on businesses in a lower-quality category.

“Folks are starting to go after those true restructuring or just above restructuring businesses more,” he said. “We’re even seeing more traditional nondistressed funds going after those.”

Simpson said that he expects to see larger funds starting to dip into the middle market as pressure from limited partners to deploy capital rises.

“LPs want to see sales, but not buys, which is creating an interesting tension,” Simpson said. “Keep an eye on LPs that don’t have dry powder for when capital funds come and how sponsors deal with that.”

One trend we continue to see is that as limited partnerships struggle to meet their capital commitments, businesses double down on core assets and cleave off noncore appendixes, selling them for cash to pay down existing debt.

Simpson said that the types of deals in the pipeline will involve “good businesses with bad balance sheets.” In addition, he noted that as the baby boomer generation grows older, industries plagued with succession issues, namely healthcare practices, will continue to sell to larger groups.

In 2024, the regulatory environment would change dramatically, Simpson observed, with the Federal Trade Commission and Department of Justice’s proposed merger guidelines for 2024. Simpson said that these new antitrust efforts would fundamentally change how private equity deals are executed.

The new guidelines require disclosure of all private equity sponsors, limited partners and transactions, whether reportable or not, Simpson explained. The new process for making a filing would be time-consuming and costly.

As a result, it would be difficult for sponsors to determine when, or if, they should close a deal. He noted that smaller funds in particular would be affected, as they will not be able to afford the expensive legal process.

“If you have a deal closing in the new year, you need to be thinking about this now,” Simpson said.