Back in favour
The high-yield market has been in surprisingly good shape this year, after breaking out of the credit market freeze that began in mid 2007, with even the previously moribund European market beginning to show some sparks of life. Deals on both sides of the Atlantic that would until recently been considered improbable have crossed the finishing line. The future looks bright, as Joy Ferguson reports.
In the months before the start of the year, US high-yield issuance was nearly non-existent. The credit freeze ensured that between October and December 2008, only three US dollar denominated deals priced. It was against this backdrop that issuers and underwriters began 2009.
Under such tenuous conditions, issuers gingerly stepped back in, pricing only strong Double B credits with high yields, steep discounts and favourable uses of proceeds to attract buyers. As the New Year began, however, investors appeared to be ready to turn over a new leaf. The first deals of the year proved successful: as buyers surfaced, confidence in the market built, leading to more issuance and cash inflows. A virtuous circle had been created. Since then, even riskier deals have been successful.
JP Morgan, Banc of America, Citigroup, Credit Suisse and Deutsche Bank led the first deal of the year: a US$844m five-year bullet offer for Cablevision. To attract wary investors, the B1/BB rated deal included a non-call life feature and a deep discount at 88.885. Proceeds were used to take out Cablevision's FRN due 2009.
The notes initially traded up to 92 in the week of pricing. This proved to the market that buyers were back. MetroPCS, Fresenius US Finance II, Nielsen and a host of energy related issuers followed suit, pricing mostly high quality offerings at attractive prices, in what were considered blow-out deals. The spigot had re-opened.
Investors found new issues very attractive relative to the secondary market and to CDS. "There is cash out there for the shrinking universe of companies that are considered to be stable in the current economic environment," one investor said early in the year.
A question of quality
The market remained heavily bifurcated for most of the year. While high quality companies could get deals done, albeit at higher prices than they would have liked, many of the riskiest, most leveraged entities were left out in the cold. The unlucky ones have since filed for bankruptcy protection.
Concerns remain that there is a massive amount of highly speculative paper maturing in the near-term. Worse still, Triple C issuance has been minimal this year, with investors remaining relatively risk averse.
According to an S&P article published in August, US$695bn in outstanding debt will come due through to 2014 for companies rated B– or lower, with either a negative outlook or ratings on creditwatch with negative implications, or for those companies with issues trading at more than 1,000bp. That amount includes bonds, loans and revolvers. Most of these issues are rated Triple C. The bulk of companies within this group are rated in the Single B category.
In the past few weeks Triple C deals have begun to trickle into the market in larger numbers than has been seen for the past two years. Issuers are securing the deals with first liens and offering hefty yields to get them done, but demand has been there.
That's good news for default rates, which, at Moody's, have already been revised downward from earlier predictions. For an increasing number of companies, the risk of covenant violation or the inability to refinance is subsiding.
The default rate hit 11.5% in August, up from a revised level of 11% in July, but the outlook is improving. In September, Moody's predicted the global speculative-grade default rate will peak at 12.6% in the fourth quarter of this year before declining sharply to 4.3% by August 2010. Back in January, the agency had predicted the default rate would peak at 16.4% in the fourth quarter. JP Morgan also revised its forecast down earlier this summer.
Betting the house
This turnaround has been reflected in the performance of a number of individual corporates in the sector. MGM Mirage, for instance, was on the brink of collapse, before completing a life-saving financing in May that raised US$2.5bn. A full US$1.5bn of that came in the form of a high-yield bond, with the rest comprising equity.
To attract investors, the company pledged two of its most profitable casinos as collateral. MGM Mirage returned to the market in September with US$475m in Caa2/CCC+ unsecured notes, signalling just how much risk appetite has increased.
Harrah's also turned the corner after it successfully executed large exchange offers, followed by two sizable bond offerings and most recently a US$1bn term loan that was heavily marketed and bought by high-yield bond investors.
Technicals have been a driving force for this positive about-face in the market. Strong inflows have been reported for all but five weeks in the year to date. Average spreads and yields have tightened dramatically over the year, as liquidity and confidence returned. This has spurred even more issuance, as companies found levels increasingly attractive.
According to the Merrill Lynch Master II index, spreads have moved in from 1,784bp at the start of the year to 789bp on September 25. The average yield was as wide as 19.46% on January 2, compared to 10.17% on the 25th.
Total US domiciled high-yield issuance for 2009 as of September 29 amounted to US$85.289bn from 192 deals, according to Thomson Reuters. This compares to just US$34.14bn for all of 2008.
Looking forward, issuance is expected to remain healthy throughout the end of the year as long as the positive tone persists, particularly as fundamentals are starting to show signs of improvement.
"We are seeing a continuation of flows into the market and now there’s some stability on a fundamental basis. High-yield will be an exciting place to invest over the next few years," said John Cokinos, head of high-yield capital markets at Bank of America Merrill Lynch.
In Europe, activity was muted compared with the US this year, in part because many leveraged businesses had completed their refinancing needs prior to the summer of 2007. But as confidence has built throughout the year, the number of deals is now on the upswing.
Initially, issuance that was heavily skewed to the dollar due to that market's strength. A dual tranche US dollar/euro offering from Fresenius Finance marked the first deal of the year, pricing on January 15. Demand was strong, with US$2.5bn in orders on both tranches, but it fell short of prompting a re-opening of the market.
Nielsen Finance priced a dollar deal a week later that was used to buy back sterling notes, but the next deal to price wasn't until UPC issued a dual tranche US dollar/euro deal in mid May.
Pernod Ricard's €800m offering, priced May 28, became the first benchmark euro transaction. Its Ba1/BB+ ratings and fallen angel status appealed to investors more as a cross-over name. Over US$5bn from just over 400 orders came in for the deal, with a huge variety of accounts participating.
Large benchmark deals from well known defensive issuers followed, including Virgin Media, which priced a dual tranche deal in late May that was still heavily dollar denominated, followed by another straight US dollar deal in July.
Wind Acquisition's €2.5bn equivalent deal made news due to its size and proceeds, which were earmarked to pay a dividend to the holdco and to repay a PIK loan. And Fiat priced two large US$1.25bn deals to overwhelming demand.
Since September, the market has shown further signs of recovery as the first Single B names got done, including Petroplus Finance's US$400m B1/BB- rated deal and CETV's €200m B2/B rated issue followed by its €240m add-on two weeks later.
"We are starting to see a broadening of the demand and the comfort of the market," said Tanneguy De-Carne, co-head of loan syndicate Europe and head of high yield capital markets at Societe Generale Corporate and Investment Banking. "It's a matter of days before we see the first time issuers and it's also a matter of days before we see a true sponsor owned company refinancing itself in the high-yield market. Those are the two next milestones we need to bridge before we can say the market is in full recovery."
To date, as of September 29, European companies have raised €14.28bn equivalent in the high-yield bond market from 18 deals, according to Thomson Reuters. De-Carne expects another €3bn-€5bn by the end of the year.
As in the US, strong cash inflows have certainly helped. Alain Stalker, a syndicate director at SocGen said: "That wall of cash combined with relatively low supply will continue to drive spreads tighter, but investors will also have one eye on the fact that we have arguably reached a point at which spreads imply a default rate lower than that which the agencies anticipate will be reached at its peak."
And as the gap between bank and bond spreads narrows, companies that would in the past have funded themselves with bank loans are turning to the bond market. "There's been a structural change in the market which again supports the fact that the future is bright for the non investment-grade market in Europe," said De-Carne.