Speaker 1:
Welcome to TD Cowen Insights, a space that brings leading thinkers together to share insights and ideas shaping the world around us. Join us as we converse with the top minds who are influencing our global sectors.
Larry Wieseneck:
Welcome once again to another episode of our Intellectual Capital Podcast series. I'm Larry Wieseneck, head of Corporate Investment Banking at TD Securities. And once again, I'm joined by my good friend and former colleague, David Erickson, senior fellow at the Wharton School. Also joining us today is Damian Engen, Global Head of Investment Grade Debt Capital Markets here at TD Securities.
With that, let me turn it over to David to get things rolling.
David Erickson:
Thanks Larry. So it's been about a year since the TD Cowen merger was completed. Let's kind of roll the clock back and talk about some of the biggest successes you've seen since the merger.
Larry Wieseneck:
Well, I'll just start with the heavy lifting that went into bringing together two organizations. So much of it's now behind us. And so now 14 months, 15 months on, just really, really thankful to all of our partners at the firm who helped us get to the point where we now are operating for the vast majority of our businesses, off of one broker-dealer here at TD Securities, and the ability now to operate with our clients as one team.
We've learned a lot during that period about the challenges of running a business when you're waiting for regulatory approvals, and bringing the technology together. So if nothing else, one of the great lessons, successes if you will, is we have a far better appreciation of what our clients go through when they're buying businesses or selling their businesses, because everything's great on paper, but working through those processes takes a lot of work. So we're really happy to be now on the other side of the majority of that effort.
From a client standpoint, what's been fantastic is seeing that clients really do want to feel the breadth of our full-service offering. This transaction was announced in late summer '22, we closed in the spring of '23, we completed the integration in the spring of '24, and here we are and in a market where many of our global competitors, for a variety of reasons, are in either neutral or reverse in terms of having to step away from certain markets, having to shrink their balance sheets. As an organization, we want to step up and be there for our clients.
So that also feels really good to be in growth mode as one of the few full-service firms around the world that wants to take on more opportunity and solve more problems for clients. I think that's been the big success has been being embraced by clients as we bring that to market.
David Erickson:
So Damian, I recognize the capital markets businesses have also come together in the past year. How has that benefited clients?
Damian Engen:
Yeah, look, we've always had a client-first approach to our capital markets advisory business, and I think we've made a concerted effort to ensure that as we provide advice to our clients, we're doing it in a way that is product and currency agnostic. And frankly, I've heard routinely from clients over the years that they really appreciate that unbiased product, and not agnostic way that we approach any capital structure discussions that we have with them around their broader financing needs.
I think the thing that has changed the most from that perspective, and it ties back into what Larry was just saying, is that we now have a stronger complement of products where we have the depth and breadth to truly provide, and capabilities to provide the advisory role that we would like to play for our clients. And so by creating a broader capital markets advisory business that's encouraging the cross-pollination across our debt equity leverage finance teams, it creates even more synergies and idea generation there in a way that I think gives clients comfort that regardless of who they reach out to on our teams within the capital markets team, they're going to get the optimal financing solution, whether the right strategy there is a bond issuance, an equity raise that converts, securitization, a term loan, or frankly anything in between.
Larry Wieseneck:
Years ago when we worked together in an organization where we had pulled the capital markets together, we would kid around and say that we were creating the Grand Central Station for capital markets. Nice thing about our structures, we literally are 30 yards from Grand Central. So it really is a one-stop destination for the ability to deliver capital market solutions.
David Erickson:
Product agnostic, as we found, is client first, so that's the way to approach it.Normally on this podcasts we'd either talk about the IPO market or the M&A markets to get started, but given both are still pretty quiet, I figured we should start with a market that's been quite active, which is the investment grade debt market. So Damian, what have been the biggest developments this year that clients should know about?
Damian Engen:
A couple of interesting developments. I'd say that one of the most visible, at least from an outside perspective, is probably the fact that tertiary yields have actually remained higher for longer than most graduates had expected. And so if anything, we actually continue to see that drifting north over the last couple of weeks here. Obviously this comes on the heels of a zero rate environment that may have had some of our issuers being complacent about the risk of higher rates.
If you look back to the beginning of the year, investors were pricing in five rate cuts, anticipating the Fed was going to begin its ceasing policy as early as March. Here we are a day away from June and still not seeing anything on the near term from that perspective. So those forecasts have continued to get pushed back further and further. We've gone from talk of a soft landing to talk of a no landing with frankly, the Fed stuck circling in a holding pattern.
And so as a result, a couple of interesting things have come out of that. The first is just the Treasury curves remained remarkably flat with only a 20 or 30 basis point delta between two-year Treasuries, ten-year Treasuries, thirty-year Treasuries. Had dynamic debt we hadn't seen for some time. And then on top of that, despite the higher Treasury yields, we've actually seen the iron market remain incredibly active. And that kind of goes contrary to what I think most people would expect, but we're on track at this point for near record level of new issues volumes surpassing anything we'd seen aside from the Covid induced surge that we saw back in 2020. And it's volume that has been fairly broad based. There's no one sector that's been responsible for that. It's been heightened activity across financial, healthcare, utilities, you name it, driving a lot of that volume, and actually driven by the fact that there has been a front-loading of financing needs that this results to get some potential market volatility related to the US election in November.
So that is something that I would note here is that heightened geopolitical risk is another component to this. We continue to see not just the election concerns in November, but whether it's concern around escalations from a bit of a regional war in Ukraine, Russia, to the potential for heightened activity in the Middle East, to potential additional concerns around China, what those might mean. There is a real dynamic at play right now that continues to have some investors on edge.
And I think this is probably the most surprising piece of all of this then David, is that we've actually seen, despite the record volume, despite the geopolitical risk, credit spreads remain at historic lows. The investment grade credit index today is trading in the 95th percentile, levels we've rarely seen over the last 20 years, and largely driven by the fact that you've got yield focused investors who've been drawn to the investment grade corporate bond market where for the first time in really over a decade, they've actually had all-in coupons that look attractive from their perspective.
So I do think that that's something particularly for folks who had not been as closely focused on the market would probably be surprised to hear that component of it.
David Erickson:
So obviously there's a lot of issuers out there that are stuck between the topic you talked about, which is when is the Fed going to cut and should I wait for the Fed to cut? And then the longer and longer I wait, I am going to get more volatility associated with the US election, or some of the geopolitical risks you were talking about. If you were a client with a significant amount of issuance to do, Damian, how would you think through that conundrum?
Damian Engen:
Yeah, no, no, look, and it's a question we've gotten from a lot of clients. It can be tough, I think for people to look at locking in current funding costs when you've been used to the zero rate environment for years, especially if you think that the forward direction is for rates to be moving lower.
So a couple of things I like to have people keep in mind. One, credit spreads that I mentioned earlier are near all-time lows. They do appear priced for perfection. In fact, if you ask our credit strategist today, he'd tell you that he estimates the likelihood of credit spreads tightening by 10 basis points is about equal to the likelihood that credit spreads widen by 100 basis points. So there's an absolute skew there that I think people need to be keeping in mind. And to the extent we do see an economic environment that encourages the Fed to cut rates, it is likely to be accompanied by a weaker backdrop that pressures credit spreads. So it's actually quite possible that funding levels increase, even if you see treasury yields drop, because what would lead to that would be an economic environment that would have people more concerned about credit fundamentals.
The other piece I'd note is that if you do believe the Fed will be cutting rates, the best bet may actually be the issue now, and lock in attractive credit spreads, but you can always swap the floating and get that benefit of the move lower and benchmark yields going forward.
I guess the final item that we've raised for clients is keeping in mind that the cost of pre-funding has actually come down pretty dramatically too. The inverted yield curve has actually meant that particularly for a high quality investment grade issuers, they can fund themselves today, put the proceeds on deposits with a bank like TD, or invest in T-Bells and actually accrue little to no negative carry. And in some cases, particularly for the ultra-high quality names, actually get positive carry. So that old adage of issuing when you can, not when you have to, I'd say holds this truth today is it has at any point in time.
David Erickson:
The equity markets were at all time highs in the last week or so, not obviously this week, it's a bit under pressure this week. But given that, I would assume we're starting to see more strategic M&A buyers getting more interested. And I guess an example of that is what's happening in the energy space now or this past week and what happened in healthcare earlier this year, kind of at the beginning of the year. How much capacity is there in the debt markets for a significant M&A deal?
Damian Engen:
Yeah. Well, I'll start by saying that certainly as a DCM professional here, I'm hoping for a pick-up in M&A activity. I'd love to see that. It's part of the market that's historically accounted for probably a fifth to a quarter of volume over the last couple of years. It's probably been on the lower end of that range.
Look, what I'd say is market capacity has continued to evolve and continued to impress. I think the definition of what would be considered a jumbo financing today probably needs to change. We've seen 10 billion financings done as drive-bys just in recent weeks for story credits, which highlight the depth of the market. Over 10 years ago, I think we probably had the first of the mega jumbo deals, and the market back in 2013 proved the ability to digest a single $49 billion deal in a single financing.
If anything today, investor demand is far deeper and far broader than it was at any time back then. And the biggest difference today is that you can actually get a deal like that done with a much, much smaller premium than you did to get it done back then.
So we've seen a handful of 10 billion plus dollars deals done year-to-date. All were multiple times oversubscribed, providing the ability to price with minimal new issue concessions. It's not uncommon today to see these larger transactions that have order books that are north of 50 billion and sometimes going up into the hundred billion dollar territory.
So the other thing I'd mention, David, is that it's worth noting that issuers who are looking at large strategic M&A have other levers to pull as well. For jumbo financing, it may make sense to consider diversifying. So you don't need to just think of the US dollar market as the place to be accessing issuance. You can lean on foreign markets, you can look at other currencies. And so it broadens that demand even further, and obviously could be paired with short-term loans that provide additional flexibility. So the ability to get just about any transaction done on a large scale in this market, it's hard to think that there's not capacity for just about any deal out there today.
Larry Wieseneck:
The bigger question is actually not whether it can be financed, but whether the appetite is there for the mega deals among corporate and in corporate boardrooms. And one of the things I think we're expecting to see over the next 12, 18 months is certainly an increase in strategic transactions. But 90% of the dialogues we're having today are things that we wouldn't put into the transformational acquisition merger of equals type, but rather more tuck-ins, maybe buying a platform in the area, which easily for any of our investment grade clients can get digested.
So I think we're probably a ways away from where the market will be such that we start seeing deals that could in any way start stretching the capacity of the debt market, but mostly because the M&A deal making is not pending in that direction yet, as opposed to because the financing markets.
David Erickson:
So as a former equity capital markets professional, I always got to talk about the IPO market. The last couple of podcasts we've talked about the lack of IPO activity. And even though what's really surprising to me at least is the equity markets have performed and are at kind of peak levels, but yet the IPO market's been virtually non-existent over the last kind of 12 to 18 months.
So what do you think is going to actually unlock the IPO market, Larry? And when you think about potential catalyst, what are the things top of mind that you think about?
Larry Wieseneck:
If we go back to what we've talked about previously, as elements to look for as harbingers of that market getting ready to reopen. We talked about reduction in volatility, that in worlds of extreme volatility, hard enough to get secondary offerings done, let alone new issues in terms of IPOs. And we've certainly seen volatility in much of the market come down. So we are not looking at the kind of levels in the VIX, for example, that we saw 18 months ago. So I think item one, more stability generally, equity market. I would say we've got that done.
I think the second is a broadening out of the market, meaning for a while, and certainly even we spoke, maybe it was four months ago, and we had Grant Miller on, our time head of equity capital markets, we were discussing that question. He referenced, look, we got to see the market broaden from five or 10 names that are driving the indexes, to a broader based recovery.
And I think that we had started to see that. If you look earlier this year when we started to see some IPO deals come, et cetera, we started seeing a bunch of companies that have been beaten up, let's say in '22 and '23 had recovered and started to approach the market. So we did see some IPOs come.
But if you look now really since three, four months ago when the market started to question are we going to have five rate cuts, as Damian was talking about, [inaudible 00:16:14] only one rate cut that brought volatility back in. But it also narrowed out the market again in terms of there are a handful of folks who've been driving the market and many other sectors now have gone sideways or struggled.
So I do think what we're going to have to see is an environment where we're seeing a broad based strengthening in the equity market. And I hate to say we just haven't really seen that. And until we see that from an IPO standpoint, there's still enough opportunity for folks to find value theoretically in the market when you get away from the top 5, 10, 15 performers that have really driven so much of the market performance.
So that's what we're looking for. I'm not sure we're going to see that before the election. I think that what we may be looking at here, and I think a lot of our conversations are, the mandates keep building, we continue to see a lot of interest in getting ready to go public. But unless someone gets launched by, let's call it late June for July transaction, we'll be sitting here in September and there'll be a lot of focus on the election as you referenced earlier. And I think that means that the IPO market most likely is really, from any kind of robustness, we're looking at sometime after the election and early next year.
David Erickson:
So last question, and we've talked about this in previous podcasts, we've touched on areas in the market that don't necessarily get a lot of attention, but the client should be aware of. And as we're approaching really the halfway point of the year, what in your vantage point or what from your vantage points, both Larry and Damian, what should clients be looking for or have their eyes on?
Damian Engen:
Sure. Look, I'll hop in quickly. I mean, from my perspective, and I'd say my crystal ball is as murky as everyone else's. So you could take this with a grain of salt. As I like to say, try to avoid making a predictions about the future because we all know how [inaudible 00:18:09] those can be.
But one thing that does make me nervous is probably just the hurting we're seeing around forecasts. Anytime there's a really strong consistency in views, it ironically actually introduces the potential for heightened volatility going forward. Because any data point or news that deviates from that can result in a fairly rapid repricing of risk markets. And so that is something that from my perspective, I get a little nervous about, because it's not that there's-
David Erickson:
Damian, you're talking about specifically US rate forecast, yes? Just to be clear.
Damian Engen:
I mean rate forecast, equity forecast, you name it, it does feel like at the moment there does seem to be. And really I think the rate forecast piece of it is probably the most pronounced of them. But that's where I see the risk right now, at least from a debt capital markets perspective, that probably the biggest risk is around that hurting and predictions and the fact that that means that there could be the potential for really heightened volatility at some point in the future.
David Erickson:
Larry, last word.
Larry Wieseneck:
Yeah, I think the area that we should be focused on is private credit. We obviously spend a lot of time working with folks in that market. It has grown to be such a significant part of the credit market. We're still untested as it relates to what happens in a true economic downturn, I think.
We would've seen that test when the pandemic set in, but we ended up, because of all the collective activity across both the fiscal and monetary policy, what would've been a fairly significant recession was avoided. And so we actually haven't seen yet what happens when we have defaults, or even when we just have significant covenant breaches, et cetera. And to be fair, I think we're going to probably find the private credit market is not a market at all, it's multiple markets. It's like saying hedge funds, there's all kinds of hedge funds. But some of those players are very well set up for operating in a period when there's challenges to their portfolios, and I'm sure others are not equipped at all. And until we see that and how that affects those companies, the economy, et cetera, I think we don't know how sustainable that market really is. It's one thing to say lots of money going into it, but what happens when challenged?
And so I do feel that over the next 18 months, even if the economy continues to get through this, we're going to see pockets where the private credit market is really tested by underperformance and challenges. That will be an important tell for how that market continues to develop. So I would just-
David Erickson:
Yeah, that's one of the markets we've talked about in our class in the same construct. And I know the leaders of both Apollo and Aries, two of the biggest players out there have kind of said, "Nothing to look at here." But I think they're talking more about their own positions versus the overall market per se. And I think that you've laid it out well in terms of talking about there's lots of players, there's lots of potentially different markets we broadly labeled as private credit, and it's yet to be untested for the most part.
Larry Wieseneck:
Yeah, listen, yes. And I'd say, I think your comment is a great one, which is, and this is true in a lot of markets, you can't speak about the whole market by talking about how the biggest players operate, any more than you can say, "How will folks deal with their banks?" If you describe JP Morgan, TD and another one of our peers, we're not the same necessarily as much smaller, local, regional bank. And so I think we have to look at private credit that way, same thing. There's really large players and then there's many, many, many thousands of smaller players. And so that's an area that we're going to continue to monitor and obviously watch.
David Erickson:
That's where I'll leave it for today. Thank you Damian and Larry. I'll turn back to Larry to close it out.
Larry Wieseneck:
Thanks everyone for joining us today. David, Damian, always a pleasure to talk to both of you, and I'm certainly looking forward to our next conversation. And of course, I want to thank all of you for listening. We appreciate you. Thanks.
Speaker 1:
For joining us. Stay tuned for the next episode of TD Cowen Insights.
