Should I Be Financing Differently This Time Around?
Just one year ago, capital markets began deteriorating in response to the initial stages of trade rhetoric and tighter than anticipated monetary policy. In December 2018, high-yield bond issuance was nonexistent for the first time since the Great Recession.
Over the past 12 months, however, a confluence of factors has contributed to a more productive financing environment, explains Eric Peiffer, head of High Grade & High Yield Capital Markets at KeyBanc Capital Markets.
As a result, most companies are now experiencing a much more accommodative landscape in the loan and bond markets. “The U.S. investment-grade corporate bond market, for example, arguably is the most attractive asset class in the world right now,” Peiffer says. In fact, September 2019 was one of the top months on record in terms of issuance volume for the high-grade bond market, as companies refinanced existing debt, funded growth, pursued acquisitions and supported stock buyback programs.
Amy Carlson, head of Debt Capital Markets at KeyBanc Capital Markets, points out, “Despite some periods of volatility, the loan market has been resilient, and both banks and institutional lenders are hungry to put money to work for well-structured deals. There’s plenty of liquidity looking for a place to earn a respectable return.”
Pursuing Strategic Initiatives
The strength of the current financing environment is underpinned by several trends, according to Peiffer. The seemingly permanent low-interest rate environment continues to benefit issuers; bonds issued by a number of well-known companies in Europe, for example, now carry sub-zero yields. This means investors like pension funds and insurers are essentially willing to loan money in exchange for the reliability and liquidity of owning high-quality corporate bonds. Consequently, significant capital is flowing from Europe and other parts of the globe into the U.S. capital markets in search of yield.
With a favorable state of access to capital, three-quarters of middle-market firms surveyed plan to expand over the next six months, according to KeyBank’s Q3 2019 Middle Market Business Sentiment Report.* Some 61% of companies plan to make significant equipment purchases. About 51% plan to add new facilities and locations. And 49% plan to renovate or expand their current facilities.
At the same time, the report found that companies are concerned about factors that could negatively influence the financing market, such as tariffs and trade agreements. And Peiffer says he is beginning to encounter questions from clients as to how the 2020 election may impact the financing market. For example, could the election result in a partial reversal of corporate tax cuts or a reduction in market volatility?
Against the backdrop of market and election uncertainties, companies must take a careful, informed and analytical approach to financing. A company’s borrowing options include fixed and floating-rate structures across the loan and bond markets. Companies enjoy significant ability to manage their debt maturities and interest rate mix and can also approach these financing markets simultaneously. “For example, they might upsize the loan offering and downsize the bond issuance or vice versa,” Carlson says.
The universe of investors is growing as well. For example, Carlson says middle market firms can tap institutional investors, such as pension funds and insurance companies they might otherwise overlook.
With so many options and the possibility of changing market conditions, companies need to ensure they are receiving good advice. “Companies want to work with a financial advisor who follows the markets closely and who is able to counsel a client based on their specific financing needs, while also considering the philosophical financing views of the company,” Carlson says.
Tailor Your Options
Financing strategy should be tailored to the individual business. Companies that are cyclical or have debt maturing in the next two to three years should give careful thought to their refinancing strategy.
Given the current accommodative state of the loan and bond markets, companies should consider the full extent of their options. A company that has, say, traditionally financed through loans might find it has reached an inflection point where issuing fixed-rate notes makes sense. “You shouldn’t go down a path with a client simply because that’s what the company has always done,” Peiffer says.
The key is not to become stagnant. Waiting for the lowest possible rate can also be risky. “There was no shortage of companies in 2007 hoping to refinance or even finance an acquisition at just a little lower rate when the market unfortunately turned,” Peiffer says. “Issuers really need to access their financing needs when the market is in their favor.”