Capital Markets

IPO comeback: What’s driving the uptick?

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David Rawlings: Hi. You're listening to What's The Deal, our investment banking series here on J.P. Morgan's Making Sense podcast channel. I'm your host, David Rawlings, Country Head of J.P. Morgan in Canada. Today, we're exploring the current state of the IPO market. Joining me is my friend and colleague, Keith Canton, who leads Americas Equities Capital Markets. Keith, welcome.

Keith Canton: Thanks, David. Really appreciate you having me today. 

David Rawlings: Listen, before we dive in, why don't you just spend a minute to tell our listeners a little more about you and your role here at J. P. Morgan?

Keith Canton: Yeah, absolutely. I've now been in banking for over 20 years, but I actually started my career in publishing at Sports Illustrated Magazine. Currently, I run the Americas Equity Capital Markets practice, so really responsible for all of our IPOs, public equity, but also our private equity placement business as well. When I joined J. P. Morgan nine years ago, I was hired to actually found and build out that private capital markets platform.

David Rawlings: So we get lots of questions from the 20-year-olds who say, "How do we get into banking?" How did you make that shift?

Keith Canton: Well, coming out of Sports Illustrated, I was not quite qualified to make the leaps specifically into banking, so for me my route was going into business school, and I ended up joining Lehman Brothers as a summer associate in 2001, and a full time associate in 2002. 

David Rawlings: And where did you go to school?

Keith Canton: I went to Fuqua School of Business at Duke University.

David Rawlings: Go Blue Devils.

Keith Canton: Yes, sir.

David Rawlings: Awesome. Listen, I had Lorenzo Soler, who is our Global Head of Equity Syndicate and a very good partner of yours, and we talked about IPOs. Let's just play a clip from last year's discussion with Lorenzo.

Lorenzo Soler: In terms of what our investor's looking for, what types of quality businesses are they prepared to buy, I would say there's massive focus now on structural growth stories with profitability. The days of 30 to 40% top-line with less of a focus on bottom-line are behind us for now.

David: What he said was there was this shift away from high growth unprofitable to more disciplined and profitable. We'll get into this in a second, but when you think about your day, volume is about 15 billion up materially from last year. So I shift to you, is the current activity consistent with that approach?

Keith Canton: Yeah, I think Lorenzo was spot-on. When you take a step back, you know, on the face the market looks quite positive. The Nasdaq, S&P are both effectively at all-time highs and really equity capital markets are up across all products. Follow-ons and blocks are up a combined 65%, converts up about 65%. And I know we're gonna focus here on the IPO market, but the IPO market right now is running about 2X what it ran last year. And you're spot-on, $15 billion raised year to date. First is just under 20 billion for all of last year. So we feel quite good about where things are.

David Rawlings: Now, I would say 2023 that's not your bench-mark years because that was still a tougher year, '22 and '23, but 15 billion, if you put that into the context over a longer period of time, it feels pretty healthy?

Keith Canton: Yeah, I mean, the way we think about it is pre-COVID we were running in the mid-40s from an IPO volume standpoint. That clearly jumped up to a peak of well north of a hundred in 2021, then we dropped to seven. And so we're coming off of all-time lows, 7, 20. And based on what we're seeing, we would expect the IPO market to end up in the 30s from a volume standpoint.

David Rawlings: Good, so almost back to normal. But you know, it's been dominated by some big deals, and you might wanna highlight a couple of those particular transactions for our audience.

Keith Canton: You're absolutely right. I mean, when we think about where we are in the market, maybe just taking a step back, deals are getting done and they're getting done well. The deals are working, they're getting done across all sectors. And to your point, they're actually getting done in size. This year, the average deal, the median deal when you take out biotech is close to $700 million. We're seeing quite sizeable deals and this year we've already had four or five billion dollar plus transaction, which is really showing the investor sentiment to get transactions over the finish line.

David Rawlings: And when you say investor sentiment, take that one step further. Is it a different type of investor that's showing up today versus last year? Like what's the composition and how's that changing?

Keith Canton: You know, I think the biggest positive we've seen this year is really much broader participation across the landscape. So the mutual funds have actually started to come back in a very big way. And you're also starting to see generalist portfolio managers come back into the market. And what that does is it really allows for more larger IPOs, particularly those IPOs placed with really fundamental investors. So we're reducing the reliance on sector-focused portfolio managers who might be size-constrained and hedge funds who might be more likely to churn in the after-market. And so the marginal IPO dollar, we can actually place that now into stickier hands. So it's really good to see the mutual funds and the generalist PMs come back into the market in a really material way.

David Rawlings: And then what about across sectors, is it consistently strong across sectors?

Keith Canton: Historically, technology is the dominate sector within the IPO market. We're not really there. In this market we've seen five tech IPOs this year out of about 30. So we're seeing broad-spread participation, consumer, industrials, financial services. Insurance has been a big part of the market so far. And in healthcare. Healthcare services meets Lorenzo's threshold of big scale profitable businesses, but you're also seeing biotech as well. We are seeing deals get done across all sectors. But interestingly, deals are also working, which I think is also leading investors to wanna get back into the IPO class. This year, if you strip out biotech, 80% of the IPOs in 2024 are above issue price and the median IPO is up about 20%. So the deals are working and that's really leading people to view the IPO product as really a source of alpha once again.

David Rawlings: All right, so let's strip that down in a few different ways. So you mentioned scale and profitability. I've also heard you talk about durability. So just go a little deeper on kinda what that means.

Keith Canton: When we think about what is an attractive IPO candidate, we always come back to scalability, profitability, and durability. So, are the companies really sizeable? If not, can they become sizeable companies? Are they profitable today or are they on a very clear path to profitability in the near term with a high degree of visibility? And are these durable business models? Are they providing a service or a product or solving something that is really gonna be around if the company decides to remain independent for the next 5, 10, 15-plus years? Do the business model really have durability to them? And what you're seeing in the class of '23 as well as the class of '24 IPOs, companies are checking really all three of those boxes. And if you're doing that, you're gonna get rewarded with an appropriate valuation but also the right types of investors. And if you can only check two of those boxes, and we've seen a couple of examples of big companies real business models but not yet tipping into profitability, those companies are pricing and seeing much more muted after-market performance.

David Rawlings: And then when you talked about after-market performance, why is that important?

Keith Canton: I thnk it’s important for a couple of reasons. First and foremost, people tend to think of the IPO as the event, but it's really only the first step in a journey to being a public company. On average, most of the IPOs are selling anywhere from 10 to 20% of the company, which means you get 80, 90% plus that still needs to be potentially monetized over time. And so if you show some early gains to investors and you perform quarter after quarter, you're gonna have a far bit of investors who are gonna be there to help you monetize your stake over time and really get you the maximum value for that residual 80% stake versus trying to maximize out that first 10 or 20% stake.

David Rawlings: Okay. When you think about the potential headwinds, there's geopolitical tensions and other things going on, what are you hearing in terms of pushback from the investors? And can you put some numbers around that?

Keith Canton: I think investors want to deploy capital but they're mindful that we are still facing headwinds. Inflation and labor cost are still up. And that has a big impact in the consumer sector. We do have geopolitical risk, which is incredibly hard for an investor to handicap, and to price in the right amount of risk premium there. And so when you think about all that, investors wanna make sure that they're coming in at the right price. And so what we've experienced is the traditional IPO discount has widened out pretty materially. Historically, we would’ve thought about a traditional IPO discount of plus or minus 15% when measured against what the market perceives to be the closest comparables. In this market, we're seeing IPO discounts of 20, 25, in some cases just north of 30% on that same basis. So investors are incredibly disciplined to make sure that they're getting in at the right entry price. And part of this goes back to the lessons that they learned from the class of '21 IPOs, where 3/4 of those IPOs are still underwater today. So investors, I think, are showing a heightened degree of discipline in today's market.

David Rawlings: Well, to your point, it seems to be working, as long as the company has appropriate scale and that business model is durable, there's interest. It's just you have to figure out at what price, and I think finding that intersection is what we do really well.

Keith Canton: I think that's spot on. We're very fortunate. We get to see a lot of high quality companies, and we have the opportunity to tell those stories into the public markets. And so, for us, it's really making sure we get that balance of scaled business that's showing real growth but is also very focused on profitability. And when you take a step back and think about what the market is telling us about profitability, we've seen almost a 5X change in the relative importance of profitability to growth, when we measure those in an analytical way. So the market is very much focused on profitability, but I always come back to the fact that the IPO market is really predicated on growth. It is a growth market.

David Rawlings: You had mentioned your structured equity background. I know you spend a lot of time with private equity and structured investors, and private equity's become a much bigger part of our market over the course of the last several years, across credit and equity. But if you're in this environment where companies need to be more mature, how does that impact them, and what are you seeing as it relates to your market?

Keith Canton: I think the cuurrent setup of large or in profitable companies actually plays quite well to where sponsors historically have invested their capital. When I think about the IPOs we did this year for Viking and UL Solutions, those, I think, provided quite a good readthrough to how sponsors might think about their portfolio companies. Those were both billion dollar plus IPOs. Those were both very profitable businesses with fairly low leverage on a relative basis. But importantly, over 80% of the proceeds in both of those transactions was secondary, back to the existing shareholders. And so if you're a financial sponsor that is really focused on how do I return capital to my limited partners, those two deals in particular, and there's been a few others, really, I think, provide some positive signs of life. And so when we're having our conversations with the sponsor community, we've absolutely seen a pickup in the preparedness of financial sponsors to wanna get their portfolio companies out into the public markets.

David Rawlings: Is it uncommon to see that much secondary stock in an IPO?

Keith Canton: Historically, when you're in a growth market, that would be very uncommon, because the companies really needed to raise the capital to grow their businesses. But in a world where the companies that are going public are already profitable, you really only have a couple of use cases. You can repay debt, you can think about acquisition capital, or you can give the capital back to the selling shareholders. And so just with the shift in the size of the companies, the profitability of the companies that are accessing the public market today, we're actually not surprised to see secondary proceeds be a very accepted use of funds from the buy side community.

David Rawlings: Okay. So that covers more traditional private equity. And how does this impact the venture community?

Keith Canton: The venture community is clearly one of our important constituencies. And what they're experiencing is, they're waiting a little bit longer to access the IPO market because they want their companies to grow into a sufficient scale that they'll be attractive in the public markets. Historically, we would've thought about a company with $100 million of revenue being public company-ready. That was an IPO in '20 or '21. In the current environment, those same metrics are probably closer to $300 or $400 million dollars before you're of sufficient size and scale to really attract mutual fund or a public company investor.

David Rawlings: Got it.  So let's just shift for a minute, here we are, halfway through 2024, as we think about the back half of the year, obviously we got an election cycle which we won't spend a lot of time on, but what are you hearing from investors in terms of their appetite? Do you think this market will remain resilient as we get through the summer and the fall?

Keith Canton: I think the summer and the fall should be fine. When we look at the companies that we have in our backlog, and we take a look at what we believe is gonna come across the street, I think you'll see a pretty healthy issuing cycle for the balance of this quarter, Q2, which is really June. Then I think you'll see a pickup in July, the number of companies are shooting for that July window. And then ultimately, we're gonna get into the fall. And I think the bulk of the issuance will really come in September, October. Most of the clients that we're speaking to really wanna get ahead of the election to the extent possible. And once you get past the election, your windows with the year-end holidays tends to get fairly limited. So I think we'll see a fairly active next two months, and then I think we'll see a fairly active September, October, and then it might be a little quiet then we would historically think about for the balance of the year.

David Rawlings: And my guess is, just given the time it takes to be ready to go public, you've already got a pretty good lens on that.

Keith Canton: We do. I mean, we are having organizational calls and kickoff calls for companies that are looking to IPO in October. And, as we tell our clients, if you really haven't picked your banks, picked your law firm, and are well down the path of the IPO process, you're really looking at 25 at this point.

David Rawlings: Okay. So listen, we've covered a lot of topics. Let's just bring it back home. We're in the advice business. You spend a lot of time giving advice to issuers, you also understand deeply what the investor wants. Can you just talk about what advice you are giving to corporates today?

Keith Canton: Yeah, I think two things really jump out at me when I think about what companies oftentimes don't think about when they're ready to go public. One is, how do you want the public markets to view your company once you're public? What are the KPIs that you wanna be able to tell quarter after quarter, that you wanna be judged on by the market? So start thinking about what those KPIs are today, start thinking about how you're tracking those KPIs today. And that's critically important. A lot of times companies get to the public market, and they haven't really thought about what narrative they wanna tell one, two, three quarters down the road. So I think that's particularly important. The other thing that we always focus on with companies is, make sure you can predict your business. The public markets reward consistency and predictability, and so, as you think about putting the financial model together, you wanna balance being aggressive with what can you actually deliver? And there is nothing that destroys credibility for a newly public company than missing the market's expectation in the first couple of quarters. So those would be the two things that, as we think about advice to our potential IPO clients, that we really try to hammer home.

David Rawlings: Yep. And then I think the third one you touched on earlier, which investors recognizing that this is a market you can get sized on, but you have to be less sensitive on discounts. Let's get a successful deal done, let's set ourselves up for multi quarters of performance, and then we can continue to monetize into the future.

Keith Canton: Spot on. There is a lot of equity to sell once you become a public company. The IPO is incredible, but it's just one step on the journey to being a public company.

David Rawlings: Well said. Okay, good. Listen, to recap, today we explored the IPO market, we discussed the recent uptick in activity, the changing landscape, and some notable trends across sectors and regions. Big thanks to you, Keith Canton, for joining me. Valuable insights as always. 

Keith Canton: Thanks for having me, David. 

David Rawlings: And thank you to our listeners for tuning into another episode of, What's the Deal? I'm David Rawlings, until next time, thanks for listening.

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What’s The Deal? | 2024 Outlook: Windows of opportunity, bouts of volatility 

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Kathleen Darling: Hello, and welcome to What's the Deal, our investment banking series here on JP Morgan's Making Sense podcast channel. I'm your host today, Kathleen Darling, a member of JP Morgan's debt capital markets team. Today, we're diving into the dynamic world of capital markets with Achintya Mangla, global head of equity capital markets, and Kevin Foley, global head of debt capital markets. Achintya, Kevin, great to have you both on the podcast.

Kevin Foley: Thanks so much for having us, Kathleen.

Achintya Mangla: Kathleen, thank you for having us here.

Kathleen Darling: It's certainly been an interesting and dynamic year for capital markets. Let's first start with a quick year in review. Can you both name one or two major highlights for capital markets in 2023, Achintya, let's start with you.

Achintya Mangla: Sure, Kathleen. I would say the key word is resilience. And I would put it in two buckets. I would start with technology. I think going into and transitioning from a very low rate environment to the current rate environment, there were a lot of question marks on what happens to the tech sector. And I think resilience is the key word when we look at the entire global tech landscape. Away from the performance of the big seven, which is significant and driving a large part of the market gains. I think we have seen companies starting to successfully navigate the journey in profitability while maintaining some element of growth. And I think that balance of growth and profitability is something that we got to give both shareholders and management of these tech companies a lot of credit for achieving in a very credible way. They're reducing cash burns and achieving a business model that can sustain these rates. And at the same time, we continue to see meaningful innovation in the tech space. Clearly, the last 12 months or more have been inspired by AI and large language models, but it is more than just one or two companies. It is the entire ecosystem of innovation. And some of it, the evidence we will only see a few years later, because while the private capital markets in later stage companies have been slow, the reality is we have seen a very meaningful pickup in early-stage venture financing for the tech companies, which really points to greater innovation. So that's on the tech side. I would also say on the secondary markets, and I was wrong once again. When I started the year, I don't think I would have predicted the S&P and NASDAQ to be where they are. But I think the markets have been incredibly resilient, really driven by optimistic data on the inflation side and good earnings data. What's interesting, though, is the primary activity on the equity capital market side hasn't really caught up with the secondary markets, and I think that's unusual to have such a low correlation between a very strong secondary market, but rather muted primary activity. So resilience, Kathleen, is what I would say is the key highlight.

Kathleen Darling: Great. Kevin, can you pick up on that?

Kevin Foley: Sure. I'll play right off the term of resilience, 'cause it's definitely been the factor in the credit markets as well, right? We've had an economy that's been more resilient. We had an employment picture that's been more robust. The conviction around the end of fed hikes has set off a rally here along with the optimistic view of inflation being under control and with the consumer spending remaining robust, all of that has driven a rally here in the last six plus weeks in the credit markets. It's also been helped by the fact that there has just been a lack of supply in terms of primary market, so you have an environment right now where the need to come to the market for refinancing, is limited. You have a muted M&A picture. And you have limited Capex investment or balance sheets that are well-funded already for those investments. And that's keeping new supply limited in an environment where cash is still abundant and there's a lot of liquidity looking to be put to work. And that's creating a very positive technical for our markets, across investment grade, leverage loans, high yield bonds. All of them have had the benefit of having demand outstripping supply, along with a more optimistic view of the economy and where we are in the rate cycle. That has driven a nice rally here at the end of the year. That has definitely been the biggest surprise of the year, and obviously the delay or potentially avoiding of a recession has been one of the biggest surprises of the year.

Kathleen Darling: There's a lot of uncertainty in the year ahead, from geopolitical concerns, the macro backdrop, both in regards to rate movement and a potential recession, as well as an upcoming presidential election in the US. We recently had Jay Horine, head of North American investment banking, on the podcast, and he's approaching 2024 with cautious optimism. Kevin, we've heard you stress the word caution before, so let’s dig into that.

Kevin Foley: I think cautious optimism is the right way to term the year. Yes, there is a reason for optimism given what we've seen and the resilience of the economy what looks like a conclusion of fed hikes, because the inflation data has been encouraging. But to declare we're out of the woods, it feels like it's a bit premature. We definitely have the impact of higher rates still working its way through the system. The consumer has been resilient, but that's because the jobs picture has held up. But what is going to be the impact on higher rates on businesses, individuals, as a lot of that still works its way through the system, regardless if inflation is under control or not. Higher for longer feels like it's the mantra. There's a lot of optimism out there about cuts coming from the fed as early as the second quarter of next year. That feels like it might be premature, to be drawing those conclusions. So a lot to be played out. Reasons to be optimistic, but there's also a lot of reasons to be cautious too. So I think we go into it hoping for the best but preparing for the worst. What we're telling our issuers and borrowers right now is there is a good environment. We are coming off the highs that we've seen over the past year. It's a good environment to go out and try to take advantage of the market technicals. When you look at spreads in the high yield market as well as in the high-grade market, neither one is indicating a recession. Or even the possibility of a recession. We're well inside the recessionary averages on a spread basis. We're inside the non-recessionary averages as well. So this is a good backdrop to take advantage of it. You mentioned the geopolitical concerns. Those are still hanging in the balance. We've got a presidential election. We've got the uncertainty around the economy. And there's always the known unknowns that could be a factor. When you look at QE and QT, these are unchartered waters that we're navigating through. And the side effects of that are to be determined.

Kathleen Darling: Achintya, what are your thoughts?

Achintya Mangla: Look, I agree with Kevin, but I would divide the world into I'm cautious on certain elements, and I'm optimistic on some others. And I'm really cautious on the secondary markets. Kind of a reversal of the highlights that we saw in 2023. I think geopolitics, we've talked about it, but an interesting data point that I heard and this might not be entirely accurate to the number, but there are, I think, elections in about 40 plus countries, which represent approximately 40% of the world's population, and 40% of the world's GDP. That is a lot of overhang, and probably unprecedented in recent history. I agree, I think the investors, both [inaudible 00:10:00] equity and credit, are probably being a tad too optimistic on the rate cuts. And I think the other two reasons to be cautious are we are yet to see the impact of lower inflation in corporate earnings. And I think that will drive equity markets to some extent, because the multiples are reflecting the expectation of lower yields, lower inflation, but the earnings are not yet reflecting an impact of lower inflation. So cautious on the secondary markets. I am a little bit more optimistic in terms of primary activity on the equity capital market side. This includes IPOs, follow on offerings, private capital. And it's really driven by various issues, including some companies will need to provide liquidity to shareholders. Others would have made a significant journey towards a business model which combines growth with profitability. And hence, are ready to go public. Yet others would have gone through a phase where they have reduced the cash burn, and haven't needed capital yet to grow further, but the time has now come in 2024 to take advantage and capitalize on the developments that they have needed. And of course, I think we might also see some equitization of balance sheets as corporates around the world start to prepare themselves as they should, for a higher rate environment and a higher rate for longer. So I think cautious optimism is the right way to look at it. Perhaps with a slight reversal of the trend we saw in 2023.

Kathleen Darling: Achintya, in an earlier episode, Lorenzo Soler, head of global equity syndicate, talked about the IPO markets, and he was really focused on quality, that being high quality names, the quality of engagement from the buy side, and the quality of cornerstone investors. How are you thinking about quality as we approach 2024?

Achintya Mangla: Look, I think that's exactly right. IPOs have had a tough time, right? We looked at 2021, 2022, and that class of IPOs has clearly end up [inaudible 00:12:35] as we look at the IPO class of 2023 to 2026 the next cycle of IPOs, I am confident and hopeful that they will give investors the performance expected from the IPO class as well as shareholders and employees the returns they expect as well. That's largely anchored in the quality of the companies going public. There is a lot of liquidity with investors, and investors are absolutely willing and have the risk appetite to invest in IPOs, but the bar has gone high in terms of growth, profitability, quality of management, corporate governance, and scale, to some extent. And yet I do believe that the muted activity of IPOs in 2023 was driven as much by supply as by demand. I think the market is there, the liquidity is there. In fact, we've seen a lot of investors become cornerstones, which is a relatively new trend in North America which shows their keen desire to participate and get a fair allocation in IPOs. But yet, it is also driven by the fact that, as we talked earlier, some of the shareholders and companies are not ready to go public yet. They are on a journey to change their business models, reduce the cash burns, position for a very different market environment than we have seen since 2008. And I think as that journey gets closer to completion, you will start seeing a lot more IPOs in the next couple of years. I don't foresee a first quarter of '24 or the first half to suddenly go back to pre-COVID IPO levels, but I think over the next few quarters, we will gradually go back to an environment where IPOs are a very viable and important aspect of the capital markets. An important tool for private equity venture capitalists and other corporates, and investors start seeing the returns, though I would say that one of the things... And you know, we're working with a lot of investors and corporates, is we go to divert the attention from just the day one performance of an IPO to really the midterm and the long-term performance. And I'm really hopeful that as we keep tracking the delivery of a company versus what it's promised at time of the IPO, three months, six months, 12 months from the IPO, that could align well with shareholder returns. So I think a lot more to happen in the next few years. Interestingly, I think there are a few geographical trends as well. Clearly North America will continue to be the largest and the broadest market for IPOs. And I think we'll continue to attract a host of international companies including European companies.

Kathleen Darling: Can you talk a bit about which specific markets you're keeping an eye on?

Achintya Mangla: The two markets that I think we will see increased activity, particularly relative to pre-COVID is going to be the Middle East and India. I think those are two markets where we're seeing a lot of momentum in terms of domestic liquidity, in terms of local economic growth, private company formation and hence, IPO activity. And the last one is eventually we will see Hong Kong market activity pick up as well. So I think we're really focused on IPO as an asset class, but less so quarter by quarter, more so in making sure that the next class of IPOs over the next two, three years really delivers everything that IPOs are expected to, both from an investor as well as a shareholder perspective, with quality being absolutely the cornerstone and the foundation of a healthy IPO market.

Kathleen Darling: Kevin, switching over to you. Talk to us about your expectations for the debt capital markets in 2024, specifically what are you anticipating across investment grade, high yield, and leverage loan markets? And what do you anticipate the key drivers to be for market activity?

Kevin Foley: So from an investment grade standpoint, we expect issuance volumes in the bond market to be flattish to slightly up in 2024. From a high yield perspective, we're forecasting up around 25%, and from a leveraged loan perspective, up 10%. Probably expect to see similar volumes that we've been seeing in the fourth quarter of 2023 continuing into the first six months of the year and are hopeful that we can see a pickup in activity in the back half of the year, kind of even out to those numbers that I cited. M&A, M&A, and M&A is going to be the three keys in terms of what next year's going to look like. In order to get volumes up or to even hit those levels certainly in the high yield market and leveraged loan market or to exceed them, it is going to be tied M&A. As we were hopeful that if we're getting more clarity on the economic picture, more confidence out there, that we're going to see a pickup in M&A activity. There has been a lot of activity in the fourth quarter in terms of behind the scenes, not necessarily announced in financing commitments being put on the tape, but activity is picking up, and it feels like that is tied to the increased confidence, where we are on the economic cycle, where we are on the rate cycle. And belief that valuations are finding their level, right? We've spent a lot of 2023 of buyers and sellers trying to work through matching up on where are clearing levels? What I often like to say as I'm working through the stages of grief that everyone is past denial that the world has changed and we've gone through a correction, but we've been working our way to that final stages of acceptance. So that is going to be the key for next year in achieving that forecast, particularly in the leveraged finance market. We will benefit from the fact that we start to see the maturities pick up in the back half of '24 into '25 and '26, and a lot of issuers and borrowers are going to choose 2024 as an opportunity to start to address those. There's been a little bit of hesitancy on that because of the fact that everyone has locked in low rates or low spreads. So it's been a very good environment. We've gone through the greatest refinancing wave, no one's been in a rush to go out and take that paper out, but they're gonna have to start to address that as time marches on. So we expect as the year progresses, we're gonna see it pickup in the refinancing activity, but again, the key is going to come back to that M&A picture, what the volume's going to be like and what's that going to drive demand for new financings.

Kathleen Darling: Across each of your businesses, are there certain trends you're closely watching? And Kevin, let's start with the debt capital markets.

Kevin Foley: I think what everyone is watching, what's happening with the treasury market. We're running deficits with no end in sight. You've had an environment where banks, foreign governments have been big buyers. The fed has been a big buyer of the treasury market. The regional banks. All of those have pulled back their appetite for treasure issuance at a time when the need for issuance is going to pick up because of funding of deficits. You have treasuries that have been sitting on fed balance sheet that are gonna start to come out without a natural buyer. We watch each auction. We're trying to assess demand and the pickup in supply and how that's going to play itself out. That is going to have an impact on rates, regardless of what the fed is doing. So even in an environment where the fed may be done cutting rates, the fact that you have a anticipated pickup in treasury supply at a time where demand may be pulling back from entities that have been making up the lion's share of the buyer base over the past five years, shifting, that can have a significant impact on rates. So we'll be watching each auction closely starting today.

Kathleen Darling: Achintya, what are you closely watching in regards to the equity capital markets?

Achintya Mangla: I think first, all the points Kevin mentioned are actually gonna impact the broader markets with current equity, so I think treasury markets and the rate trajectory is absolutely critical like it has been in '23. The two additional things I would say are corporate earnings, going back to my earlier point, if inflation does come down, how do corporate earnings fare? And consumer spending. I think we have all benefited from pretty robust consumer spending post-COVID, and I think it'll be interesting to see how consumer spending, business confidence approaches and what the trends are in that direction in 2024. That combined with the treasury aspects Kevin mentioned I think will define, to a large extent, the broader market sentiments.

Kathleen Darling: As we close out the year and this podcast, what is the one take away you want to leave clients with today?

Achintya Mangla: I think the one take away we would leave our clients with, and we'll continue to work with our clients with is really prepare for a higher rate environment, and we alluded to earlier in this podcast, hope for the best, but prepare for what might be less than ideal market conditions, especially when it comes to rates. And I think the thing that we're going to start working with a lot of companies and our clients is the conversation on what the right capital structure is how a capital structure should look like in a higher for longer rate environment is the one that we want all our companies and clients to focus on. And the conversation will go beyond absolute leverage levels. The conversation will include modeling in what could be the higher cost of financings as the debt maturity wall comes closer. The impact on interest costs, debt servicing costs, and therefore, the implied strategy for capital structure. And I think that'll be an interesting conversation and we will work with our clients to anticipate those changes, anticipate the refinancing as they come along and ensure that they're ready for all environments, including rate cuts. Or if indeed the market has or sees less rate cuts, then anticipate it. That would be our best advice, and as always, be nimble as the markets present different opportunities.

Kathleen Darling: And with that, Kevin, we'll round it out with your takeaway for clients.

Kevin Foley: So being a credit person versus the equity person, I'll stick with the hope for the best prepare for the worst, glass half empty folks. But it is don't be complacent. It is take advantage of the environment while it's there. There are reasons to be optimistic. There are reasons to be cautious. Our expectation is at the very least we will see some volatility in these markets, so try to take advantage of the backdrop while it's there and take the money while it's available. We're going to anticipate volatility. At what point, what's the trigger? Hard to say. But there will be plenty of windows of opportunity. There'll be bouts of volatility and that's going to be 2024 in a nutshell.

Kathleen Darling: Achintya, Kevin, it has been a pleasure having you both with us on What's the Deal to provide your insights on both the equity and debt capital markets. We'll definitely stay tuned for the new year to see how markets unfold, so thank you again for joining us.

Achintya Mangla: Kathleen, Kevin, great to speak to you both. And for all our listeners, thank you for listening and have a great holiday season.

Kevin Foley: Kathleen, thank you for having us, and to all our clients out there, thank you for all the trust you've placed in us in 2023, and we look forward to working together in the future, and happy holidays, happy New Year to everyone.

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What’s The Deal? | Ready to navigate market windows?  

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Kathleen Darling: Hello, and welcome back to What's the Deal? I'm your host today, Kathleen Darling, a member of J.P. Morgan's Debt Capital Markets team. I'm excited to welcome back Todd Rothman, a managing director with our Leverage Finance Capital Markets group, to discuss the sentiment and activity in both the leverage loan and high yield markets. Todd, welcome back to the podcast. 

Todd Rothman: Thanks, Kathleen. Great to be back.

Kathleen Darling: We have really seen a pendulum swing in markets over, call it a week's timeframe, so I think it's important to first set the stage for our audience in term of October performance and drivers thereof. When we last spoke with Brian Tramontozzi towards the end of September, he discussed how lenders in the leveraged loan market and investors in the high yield market were showing a constructive bias and a willingness to take on more risk post Labor Day, with supporting market backdrops as evidenced by 58% of loans trading above 99, and the J.P. Morgan Global Dollar High Yield Index sitting at roughly 8.8%, which was 100 basis points inside the high for the year at the time. However, sentiment quickly changed with conflicts arising in the Middle East, the 10 year Treasury crossing the 5% threshold for the first time since 2007, and key economic data coming in hotter than expected, further emphasizing this notion that rates may need to remain higher for longer. Let’s start off by contextualizing for our audience what we saw in both the leverage loan and high yield markets in October?

Todd Rothman: Sure, I'm happy to. I think it's important that we start with the precipitous move that we saw in treasuries. If we go back to the end of September, we had a 10 year that was sitting at 4.6%. If you roll the clock forward to the end of October, we were just north of 5%. That was the first time, as you said, since 2007 that we hit that level. So not only was it a large move in terms of numbers, but also psychologically had a lot of impact on market sentiment. To give you a little bit more context there, if you go back to July, the 10 year was actually just below 4%. So we're looking at 100 basis point move in base rates in just over four months. The ramp that we saw in the 10 year can likely be attributed to really a few things. First and foremost, I think was the economic data that we saw, which pointed to a much more resilient economy than the market was really expecting. And that took both the risk and some of the fear of a recession off the table. The other couple things were around the shear volume of treasuries that need to be issued and some of the supply/demand concerns that the market had there. And finally, what the market's experiencing is a bit of a shift in the buyer base for treasuries. A lot of the typical players, sovereigns and the like that were traditional buyers of treasures are steeping back, and so that's created even further supply/demand imbalance, which has helped pushed rates a bit higher. Away from rates, the other dynamic that we saw play out over the course of September and October was around VIX, or the Volatility Index. In September, we were sitting at multi-year lows of 13 to 14. We saw that climb over 75% to 20 by the end of October. So if you combine the run-up in treasuries, the overall market volatility, the end result was seeing markets trade off fairly meaningfully and fairly quickly. So with that market backdrop, maybe I'll start on the bond market and then we'll move over to the leverage loan market after that. So the bond market, in particular for tight spread BB rated credits, that market is a lot more sensitive to the move that we see in base rates. So if you take that, the market volatility, the way that manifested itself was over an eight-week period, we saw high-yield mutual funds experience outflows of over 12 billion dollars. So you take that, you take the macro backdrop, and the end result was a big move in both the High Yield Index and a slowdown in new issuance. So case in point, the first week of October, we actually didn't see a single high yield bond yield print, you'd have to go back to the regional bank crisis at the end of March for the last time that we saw a regular market week without any issuance. The rest of October, nearly half the deals that did come, they came at the wide end of price talk or wide of price talk, another sign that the market was shifting away from issuers. And then the High Yield Index in secondary, we saw a pretty meaningful move there. We started out at just over 9% in September and we widened out nearly 65 basis points to 9.7% at the bottom on October. Spreads, on the other hand, did offer a bit of solace to issuers. So, at the end of October, we were sitting in around a 475 basis point spread level. If you compare that to historical periods, the average non-recessionary average high yield spread is around 550 basis points. And for recessionary periods, it's 980 basis points. So from a spread perspective, it did look  quite attractive for issuers to enter the market and to raise capital, but we did see a bit of sticker shock set in and a number of issuers saying, "I don't wanna take those higher coupons in this environment. I'm going to wait." The other thing that that told us was, with spreads that tight, the market's probably not pricing in that material or that near term a recession or other geopolitical events that could upset the market. So now, if we turn to the leverage loan market, very similar to what I described on the high yield bond side, September was a really robust for leverage loans. So, a couple things to note that were going on. One, we had very strong CLO formation, one of the strongest months that we've seen of the year. We had north of 26% of the loan market trading above par in secondary, so a really strong sign for the robustness of the market there. And the end result of all that, between new CLO formation, a strong secondary market, we actually saw two things happen. One, we had one of our highest volume months of the year in terms of new facilities. We had roughly 59 billion dollars come through the market. That compares to a monthly average this year of just about 25 billion dollars. The other thing going on was 40% of that volume was actually related to term loan repricing, to where we took the margin down from existing levels for borrowers. Roll the clock forward to October, and similar to what I talked about tin the high yield bond market, a lot of the same outcomes happened here. So, we went from 26% of the loan market trading above par all the way down to 4%. We went from 40% of deals being repricing related down to no repricing deals at all. And the other thing that we saw, very similar to the bond market, 50% of the loans that did price in October came at the wide end or wide of price talk.

Kathleen Darling: Great. Now, taking us to present day, the 10 year Treasury
rallied roughly 30 basis points since October, 27th, closing out the week of October 30th at around 4.5%. This rally was largely driven by the Fed choosing to hold rates steady at their November 1st meeting, overall softer labor data, and a smaller than anticipated treasury refunding size. Can you talk about how markets have responded to this?

Todd Rothman: Sure. So, I think the Fed holding rates steady was really already priced in by the market. Some of the comments by Chairman Powell, however, did point towards a move dovish tone as he mentioned that their efforts to bring down inflation had made meaningful progress and that they'd continue to monitor the data to see their path forward. With that sentiment, traders are now pricing in a virtual certainty that the Fed is going to hold rates steady in December. That's only picked up in recent weeks as we've seen more data, seen more Fed speak. And this view is also in line with J.P. Morgan economic forecast that the Fed is likely to hold steady on rates for the remainder of this year and then start to take action late in 2024 with their first-rate cut. In conjunction with the Fed meetings last week, we've seen payroll data, jobs data that continues to point towards a message that the market is believing is saying the Fed is likely done, and if they're not done, they're close to done in terms of rate hikes. And it's also provided more comfort to the market that a recession is not a near term event, and that if there is one, it is more likely than not to be a soft landing than a hard landing. So the result of the economic data and treasury tightening has been that we've seen a big rally in secondary markets, both in the high yield bond and the leverage loan side over the course of the past week. The hope here is that that is going to start moving some issuers on the bond side to come of the sideline to address their refinancing needs. And we've already started to see that a fair bit this with a big pickup in volume versus last week. The High Yield Index, from a secondary standpoint, has also proved this out, so we've seen a meaningful 60 basis point move down to inside of nine and a quarter percent on the J.P. Morgan High Yield Index. And then on a similar note, we saw high yield spreads tighten roughly 35 basis points last week as well, so those now sit around 450 basis points. Back to my comment earlier, that's still sitting well below recessionary and non-recessionary levels. And then on the loan side, we've seen the exact same thing. So after having 11 consecutive sessions of secondary loan levels trade downwards, we saw secondaries start to trade up towards the end of last week, and that's continued into this week. Case in point, back to my stat around loans trading above par again, so if we bottomed out at 4% in October, we're now back up to 10% of loans trading above par, not quite at the 26% that we hit in September, but potentially signaling the beginning of September part two for the loan market as well.

Kathleen Darling: If we think about it, there're really two market windows before year-end for companies to transact, roughly two weeks before Thanksgiving, and then call it three weeks before the December holidays. What is your message to companies now in terms of executing on these windows of opportunity?

Todd Rothman: So, the first message is that markets are completely open right now. What we're talking about is optimization on pricing and terms, and what we constantly remind our borrower and issuer clients is that volatility can rear its head at any time, and if you need the money, go take it when it's there. So some of the themes that we talked about last time, Kathleen, you and I spoke, and throughout the year, on the loan side, we still talk about roughly 40% of CLOs reaching the end of their reinvestment period at the end of this year. That'll grow to slightly more than half at the end of next year. The good news is, as I mentioned before, September and the end of the summer were really good new CLO formation windows. Slowed down a bit in October, starting to pick up again in November. But the question for the loan market remains: will new CLO formation be able to completely make up for the amount that is going out of reinvestment period? And as a reminder, CLOs make up about two thirds of the buyer base for leverage loans. So on the loan side, we continue to encourage our borrower clients that there is a first mover advantage to taking care of your refinancing needs or any capital raising needs that you have today when you know what the market looks like. Similarly, on the bond side, for several quarters we've been talking about above average cash balances that high yield mutual funds were sitting on. When we got to the end of Q3, for the first time in a couple of years, we actually dipped below the longterm average, and we're kind of sitting around three and three quarter percent cash balances right now, still very good, but not as lofty as it was before. What is helpful for the technical and the high yield bond market is that we've had a number of repayments, and then you've also had a number of large rising stars that exited the high yield market as they migrated up to the investment grade market. So as I said before, markets are open, there is cash out there. The buy side is waiting for new deals to come through. The final point to take into consideration there is that we have a really, really light M&A pipeline of underwritten deals that are due to come to market. If you look at that across both loans and bonds, in the US, it's only roughly 11 billion dollars. If you add Europe in, it's only another couple billion euros. Compare that to the post-COVID peak in 2022, we hit 110 billion dollars then. So, the pipeline here is really, really small, which means that the cash is looking for a home and does create good conditions for borrowers to access the loan market and issuers to access the high yield bond market.

Kathleen Darling: As we wrap up this episode, there's approximately 740 billion of 2025 and 2026 maturities across leverage loans and high yield bonds. As companies move towards year-end and start planning for calendar year 2024, do you have any thoughts on how companies with either a 2025 or 2026 maturity should be thinking about addressing these?

Todd Rothman: So, it's really interesting. Obviously, we've dealt largely with 2023 and 2024. I don't think most people realize that we've already addressed a third of the 2025 maturities with refinancing activity that we've done over the course of this year. What surprises a number of people is the shear number of companies that are already proactively looking at 2026 as well. Close to half of what we've done this year has not only addressed '24 and '25 maturities, but actually started going after 2026 maturities as well. So, we continue to encourage our borrower and our issuer clients to think along those lines. We talked about the CLO reinvestment period fall off. So in terms of addressing the remaining 2025 and 2026 maturities, and by the way, I think by the time we get into next year, we may start talking about 2027 maturities as well, the themes remain the same. So, we just talked about the CLO reinvestment period and the importance for borrowers in that market to take advantage of the first mover advantage that's out there. On the high yield bond side, one of the trickiest things we've had to manage as treasuries have continued to gap out, even though spreads have remained relatively tight, we've had to get a number of high yield issuers comfortable with the concept that a 6% and change coupon that was available a year ago had become 7% and change this year, and now, in some instances, may be as high as 8% or higher. October was the first month that we saw the BB High Yield Index close above 8% since 2009. And so, one of the things that we remind people of is that we are in a higher rate environment, and even if one does believe in the concept that rates are going to start getting cut towards the backend of next year, the shear volume of treasury issuance that needs to take place means that base rates are likely to remain higher for longer, and therefore this is a new normal in terms of pricing dynamic for issuers in the high yield market. And finally, windows are going to come and go. I think one of the key lessons that we've learned here post Labor Day, September was a great borrower and issuer friendly month to access the loan and the bond market. October was really volatile and became a less hospitable environment for people to raise capital. Markets were open, it was just more expensive. And so, encourage everyone to remember that volatility isn't going away, get ready to go to market, and look to hit a window as soon as they open. The risk feels asymmetric in terms of cost of capital going wider a lot more than it gets tighter.

Kathleen Darling: Todd, thank you for the thorough read on the markets. Although we do not know what is to come of tomorrow, the current backdrop and supporting technicals seem to support a promising pathway to end the year for both the leverage loan and high yield markets. We will very much be looking forward to activities ahead. Todd, thanks so much for joining the podcast today.

Todd Rothman: Kathleen, thanks for the discussion. As always, enjoyed it.

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