Photographer: Scott Eells/Bloomberg

Supersized Corporate Bond Sales Are Taking a Bigger Bite Out of an $8 Trillion Market

Would you like some yield with that?

Would you like to supersize that corporate bond sale?

Companies selling their debt to eager investors have replied with a collective 'yes.' They've opted to increase their issuance of mega-sized bonds of $5 billion or more to a record $330 billion in 2015, according to data from HSBC Holdings Plc.

The trend's gained traction quickly, with a single Verizon Inc. bond in 2013 equaling almost all of 2012's mega-bond total. Such 'jumbo' issuance was novel that year, but is increasingly characterizing the market and now accounts for almost a third of total sales in 2016, HSBC analysts say. Like junk food, however, the growth of outsized debt deals comes with a health warning as it may result in a handful of huge issuers dominating the market, or allow companies to increase borrowing levels to subsidize greater payouts for their shareholders.

"It is no secret that the equity market generally rewards companies that add leverage their balance sheets, whether to finance M&A or shareholder-friendly actions such as share buybacks and/or dividend increases, in the absence of sustained organic growth," HSBC analysts led by Edward B. Marrinan wrote. "Jumbo issuance has become key to capturing this value."

Source: HSBC

While ultra-low borrowing costs and an abundance of yield-hungry investors have encouraged companies to upsize their debt sales, two other, lesser-known factors have contributed to the debt sales, the analysts argue.

At a time when the ability to buy and sell corporate debt is said by market participants to have deteriorated, big bonds sold by big companies may simply be more liquid. 

"The issuers of jumbo bonds are — by definition — large companies as measured by either their equity or debt market capitalizations," the analysts write. "Since 2015, as the pace of jumbo issuance accelerated, so too has the volume of secondary market trading in these securities."

At the same time, investors may be craving bigger bonds thanks to so-called new issue concessions that see companies reward buyers for the added risk of taking on larger chunks of their debt — especially when that debt is aimed at rewarding shareholders. By underpricing bonds when they're first sold, investors are able to enjoy a quick 'pop' in price once the debt begins trading in the secondary market.

"Many market participants like jumbo deals because most issuers have offered attractive new issue concessions (i.e. additional spread above established secondary market value) as an incentive to investors to purchase the bonds," HSBC says. "In particular, with respect to bonds issued to fund shareholder repurchases and dividend payments, debt investors require incremental compensation because the funds are essentially used to subsidize equity returns. This has led to heavy oversubscription rates, which has frequently translated into strong secondary market trading performance."

The dominance of a handful of companies in the corporate bond market has troubled some analysts who worry that credit ratings downgrades or big price drops of companies with a large amount of outstanding issuance could have an outsized effect on overall bond market returns and indexes.

SourceL HSBC

Still, sales of jumbo debt are expected to pick up as companies use the bonds to finance mergers and acquisitions, share buybacks, or dividend increases, HSBC adds.

"It is important to remember that most of such deals are a form of financial engineering that facilitates managements’ objectives of enhancing shareholder value," the analysts concluded. "The corporate sector’s embrace of leverage as a key driver of earnings, and ultimately, stock price performance, along with the eventual need to refinance these deals, makes it likely that the volume of jumbo bond issuance will continue to increase in coming years."

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