Capital markets: spring is coming

The start of the earnings season for banks represents an opportunity to oversee the smoking doom of 2022 in the capital markets.

The first signs – based on the US companies that had reported at the time of writing – are that earnings in debt capital markets are expected to fall by 40% to 50%, in equity capital markets slightly closer to 75% and in advisory markets around the 25%.

The unfamiliar picture of rising interest rates left some asset classes in tatters: global high-yield bond issuance collapsed by 80% in 2022.

Capital market bankers should hope that in 2023 there will be a healthy dose of issuer capitulation. Maybe they will get their wish, or at least an improvement in the past 12 months.

People have a natural preference for the familiar, so there is an understandable myopia in parts of the debt market

Some companies have come out of trouble as if their lives depended on it: Take European financial institutions, which posted a blistering $82 billion issuance in the first two weeks of January – the new year hasn’t been quite like it since the global financial crisis been. crisis (GFC).

FIG is an asset class that, more than most, rises and falls with the regulatory tide. This time, the drivers are tweaks to capital rules and the latest set of repayments of what was borrowed under the European Central Bank’s third targeted longer-term refinancing operation (TLTRO III).

Due to nervous circumstances last year, a large part of the usual pre-financing was also paid – there is some catching up to do.

Some corporates would do well to learn from the example. As 2022 moves into 2023, the elephant in the room is the urgent need for many lower-rated companies – from small to very large – to pay close attention to their capital structure.

If there’s one overriding theme for the year ahead, it’s that borrowers must face what they’ve largely avoided over the past year: accepting a new pricing reality.

Those who have become accustomed to borrowing at 1% must get used to 5% – and that is for the better names. And the increases have not stopped yet.

People have a natural preference for the familiar, so there is an understandable myopia in parts of the debt market; what seems most apparent to issuers is the recent period of low interest rates; longer-term norms seem hazy by comparison.

It’s a similar story in equities: investors’ views on valuations have been distorted by the heady days of 2021.

In that sense, a new year brings a great opportunity to reset. Investors’ reluctance to put money to work late in the year – for fear of jeopardizing year-to-date performance – is well known. Now issuers also have the chance to reconsider their position.

Bankers tell any client who will listen that it’s the 12 months just ended that should be their point of reference, not the crazy two years before that – or, for that matter, the crazy decade before that.

Will borrowers jump? Again, recent history is a poor guide when you consider how many people bide their time during the first year of the rate hike cycle.

Largely unthreatened by any maturity wall and in many cases having raised pots of (often unnecessary) cash when the coronavirus pandemic hit in 2020, the top-rated companies have been able to sit it out.

In that sense, last year’s downturn was different from the onset of Covid or the teeth of the GFC, as borrowers had paid off their debts while things were going well.

That will change: maturities are coming up in 2023 and 2024. And while there is a lot of discussion about the final interest rate – the highest point in a rate cycle – there is little doubt about one aspect of the longer-term horizon. When rates stop rising, they will stay high for a long time.

And when they finally fall, it won’t be zero.

For those reasons, while last year was a bad year for investment-grade corporate issues, this year is expected to be different. Investment-grade fund flows were negative in the first half of 2022, but turned positive later in the year, and there’s plenty to bet.

Much depends, of course, on the recession risk. Some bankers think the pessimists are wrong, that the recession in Europe, if it comes, could be superficial. The US might avoid it altogether.

When it comes to the inflation outlook, there are certainly indicators supporting the optimists: freight rates are falling, inventories are falling, demand is weakening, labor markets are easing (the UK being a notable exception).

So far, investment-grade business activity is lower than the same period over the past four years. High-interest issues are practically non-existent.

If the pessimists are right on the macro picture, many companies will only see more pressure on their top line as they grapple with debt loads built up in easy times.

At some point, reality has to set in. Borrowers have to accept where the markets are right now. The worst rated should seriously consider their ability to cover their interest payments.

IPO activity may be minimal for a while yet, but the re-clearing of many balance sheets should be at the top of the agenda in 2023.