Bear market blues

The revelation that JPMorgan would buy Bear Stearns for a mere US$2.00 a share early last week (now revised to US$10 a share) injected the high-yield and leveraged loan markets with more than enough caution, appealing to the pessimism of traders, investors and arrangers who were concerned over the fate of other banks nearly as debt-stricken as Bear. Now that Bear-specific fears have more or less been rested, however, leveraged debt arrangers are still unsettled.

“The liquidity crisis has largely gone away,” said one syndicate official, citing the rate cut, decent earnings reports from Lehman Brothers, Goldman Sachs and Morgan Stanley, and the Fed’s assistance to brokers. “But I think we are in a downmarket here where we still have to wait for corporate earnings and to see how bad the economy really is.”

The Fed’s action to open the discount window to brokers, which, done earlier, might have prevented Bear Stearns’ fate, helped stave off immediate fears surrounding other brokerage houses.

“The Fed’s extending immediate financing to brokers for a broad range of collateral significantly reduces the potential for a replay of a Bear Stearns scenario, in our view,” said Jeffrey Rosenberg, research analyst at Bank of America.

But nothing is certain. “That helped Lehman Brothers out for now, but things could whipsaw right back down again,” said another syndicate official.

Balance sheet

To see how the market has changed, it is helpful to note that potential issuers are looking for arrangers that can be more than just the cheapest. Pricing is still important, no doubt, but staying power, now that it is an issue, is also paramount. And that requires a balance sheet.

Given the more precarious state of some investment banks in particular, high-yield issuers that do attempt to tap the market might turn to sturdier commercial banks to get necessary deals done.

“Commercial banks with legitimate investment banking arms are in favour. This is not a commodities market,” said the second syndicate official. “It’s not the cheapest fee anymore. Issuers want a bank that has a balance sheet and they are turning to leading bulge-bracket firms.”

Furthermore, some difficulties at US firms could finally pave the way for European banks to get a piece of the difficult US leveraged market. Firms such as HSBC, RBS and Barclays Capital, for example, are less saddled with LBO debt and might have additional lending flexibility. Borrowers could go to them in their time of need.

However, to define the stronger and weaker names is not as easy as distinguishing between investment banks and commercial banks. Investment banks are going to continue to lend to back up their core business.

“When the market comes back, they’ll still want to take part,” a trader said. “Lending is a lucrative business.”

Everyone’s stingy

And any difference between the two banking business models might be traditional, rather than the result of prevailing market weakness.

“The investment banks are always a little less willing to lend compared with commercial banks,” a loan banker said. “And I think the difference is becoming more pronounced. However, no one is very willing to lend in these markets. Everyone is being less generous with capital.”

Indeed, at least for the short-term, new high-yield and leveraged loan issuance will be minimal all around. Companies willing to borrow now will do so only out of necessity.

“What you’ve got is a situation whereby the only deals you will see are transactions from companies that are compelled to raise money,” said the first syndicate official.

And issuers will have to pay investors for their troubles. Take Charter Communications‘ dual bond and loan offering two weeks ago. Facing debt maturities and a liquidity crisis, the company raised US$1bn but was forced to pay a hefty premium to do so.

The syndicate official, who was not involved in the deal, said the company paid a roughly 150bp new issue premium, which he called “unheard of”.

Price was one thing Charter had in its favour. What’s more, assisting Charter Communications through the market, too, was that nearly every investor owns some of its debt. “Everyone is motivated to help Charter to protect their own existing investments,” the official said.

Not so easy

But forthcoming refinancings from less pervasively owned credits might not come so easily. Already, Abitibi-Consolidated has faced headwinds in its attempts to refinance debt maturing in the next few months and next.

Ainsworth Lumber also failed to entice the majority of its noteholders to participate in a US$824m bond exchange offer that would have lowered its debt costs and given the forestry company some cushion during the current US housing market slump.

The offer to exchange existing debt for new bonds expired on March 14 without the conditions being satisfied. Ainsworth had extended its early participation date twice.

The company’s US$50m high-yield note offering, as part of the recap plan, through Barclays was withdrawn from the market. Ainsworth said it had a number of other alternatives that it would pursue for its refinancing efforts.

Such difficulties could portend a challenging year.

“In 2008, credits will continue to deteriorate,” said one hedge fund manager. “As long as we have credit deterioration and the refinancing window is closed, you will have defaults. The default rate will get up to 5.4% as Moody’s predicts, if not higher.”