Investors have a change of heart on debt

Corporate debt issuances outpace high-yield deals as investors push companies to take on leverage to boost buybacks and dividends.

Pile of money on scale
Adrian Samson | Getty Images

It increasingly looks like the best of times for corporate borrowers but the worst of times for private equity firms.

A Dickensian tale is playing out in bond markets, where investment-grade corporate bond issuance took off in February but high-yield issuances remain low and are regarded as practically toxic in 2016.

"So far in 2016, global junk bond volume and activity is the lowest since 2009," a report from finance industry data tracking firm Dealogic said.

It's part of a creeping trend that hasn't gone unnoticed in the private equity business. Debt financing for private equity deals slowed in the second half of last year, as credit spreads increased, a Bain & Co. report said. After four consecutive years of increasing global debt volume for leveraged buyouts, the cash available to private equity firms fell 13 percent last year, from $153 billion to $133 billion, the report shows.

At the same time, private equity firms invested more cash, in part incentivized to increased spending with the expectation of rising interest rates. The $282 billion in private equity investments were more than at any point since the financial crisis, Bain reported.

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And that means private equity firms big and small have to put more cash on the table.

Consider private equity titan Apollo Global Management's acquisition of ADT. Part of Apollo's deal to buy out the home security company included a $750 million investment from Koch Equity Development, the investing arm of Koch Industries. The private equity firm spent $4.5 billion in equity to support the $6.93 billion deal, in part because of the challenges it might have faced had it sought to refinance more than $3.5 billion in debt the company carried.

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It's not just bad news for private equity — which would prefer to have more cash on hand to do more deals later — it's also bad news for big banks, which make more off high-yield issuances than they do investment-grade financing.

But corporate borrowers are encountering a much friendlier bond market. It's just that lenders aren't necessarily expecting investment-grade rated companies to necessarily conduct any mergers and acquisitions once they've raised more cash.

The $155 billion issued in investment-grade bonds issued so far in 2016 is more than any other year-to-date tally dating back to 1995, according to Dealogic data.

A Tuesday report from Bank of America Merrill Lynch suggests the positive trend for corporate borrowers will continue.

"We expect the busy supply volumes to continue into March as well, for total monthly supply between $120 [billion] and $140 [billion]," analysts wrote.

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Some market watchers were surprised to see so much investment-grade paper move at a pace like this, given that in early February, lending markets were almost completely frozen and markets were in turmoil. Bankers who spoke with CNBC.com said they were optimistic corporate M&A would begin to pick up, as 2016's pace of deals has lagged behind the prior year.

Much of the additional balance capital going onto corporates' balance sheets isn't for more mergers, it's to pay out shareholders clamoring for better returns and bigger dividends.

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Mike Mullaney, CIO at Fiduciary Trust Co., which manages more than $11 billion in assets, says the trend reflects less M&A ambition for big corporations and more buybacks looking forward.

"This anomaly is being driven by stock buybacks, which are dominated by investment grade companies," he said. "Some companies are no longer generating enough free cash flow to do the buybacks and must borrow to do so."

Correction: an earlier version of this story misstated Fiduciary Trust Co.'s assets.