Five Questions With… Jonathan Lynch, Partner, JPMorgan Partners –

Prior to downgrades of Ford’s and General Motors’ high yield bonds, we were seeing record-breaking issuance of junk bonds. Since then, the market has grinded to a halt and we’ve only seen minor improvements. Will we ever see the amount of confidence in the junk market that we saw before the March downgrades?

High yield issuance to date is down by about a third versus what it was at this time in 2004, and I’m doubtful that confidence will be as high in the near-term and for the foreseeable future. Spreads are considerably wider than they were pre-GM because investors are generally exhibiting a lower tolerance for risk than they did previously. And as a result, investor appetite for higher leverage levels-CCC credits, smaller deals and story credits-has dissipated. So while the high yield market has made up about half the ground it lost as far as pricing since March, we’re just not yet where we were pre-GM.

Given the high yield market’s current state, what is JPMorgan Partners doing differently, if anything at all?

We have to remain cognizant that the bar to finance sponsored transactions in this environment has risen. The number of new sponsor-originated high yield issuances has slowed. As a result, financial institutions are becoming a lot more selective on the margin with regards to the sponsors and the credits they’re choosing to underwrite. For blue chip sponsors, leverage levels and equity contributions are largely remaining similar to what had been pre-GM. But as we remain active on the new deal front, we are working even closer with our financing partners to make sure their credits are going to be well-received in the bank and high yield marketplaces that exist today.

If some of today’s larger financing commitments that are outstanding fail to price, what will that mean for the future of the high yield market?

Basically these funded bridge commitments are going to remain outstanding, and it’s just going to be a function of time as to when they actually do price. It’s not like anything catastrophic happens in the near term-the take-out financing may just not come to market and price on schedule. The financial institutions that provided the capital are going to keep the paper themselves until they can price the credits at par or trade out of them.

What should we be watching out for in the high yield market?

In terms of long-term affects, it’s going to be interesting to see how default rates in the high yield markets change prospectively. Right now we’re at historical lows on default rates. And given relatively high leverage levels, at least by historical standards, it wouldn’t be shocking to see default rates pick up once we get beyond 2005.

Some would argue that we’re seeing excesses in all types of debt, not just high yield. Given today’s multiples and valuations, are firms better off just focusing on exit strategies, or can you still make money by buying properties today?

We continue to see high levels of activity in the private equity marketplace-both on the buy- and sell-side. On the sell side, you’ve got a quest for earnings growth among public companies that is driving strategics to become increasingly aggressive players in the M&A marketplace. There’s a decent balance in activity level between buying and selling portfolio companies. But you need to pick your spots if you are going to compete against strategics in the buy side of the marketplace.