The first half of 2008 saw the slowest start for new high-yield bond issuance since 1991, at $25.43 billion. April, May and the beginning of June saw an uptick in new issuances that accounted for more than 75 percent of the year’s total. But aside from well-publicized buyouts like Clear Channel and BCE Inc., deals struck pre-credit crunch, nearly all new issuances have gone to corporate borrowers with quality names and a “B” or better credit rating.
The reason? High-yield bonds backing LBOs are below investment grade, representing a level of risk investors have shown they aren’t willing to take in today’s market. “Strategic buyers have better credit and come under better terms for bond holders. They’re finding a more receptive audience,” said King Penniman, president of KDP Investment Advisers, a high-yield research firm.
Meanwhile, lenders continue to slowly unload the $48 billion backlog of bonds left over still from deals struck more than a year ago in the buyout boom. (The backlog of both bonds and loans is estimated to be around $90 billion, according to sister magazine International Financing Review.) Those bonds seem to be acting as a sponge for all of the interest in the asset class, further preventing issuers from committing to new deals.
Needless to say, without a thriving high-yield bond market, there isn’t much “L” to be had in large LBOs. Deal volume says it all: In the Americas, leveraged buyout activity for 2008 through June 10 dropped 79 percent over the same period last year, according to data from Thomson Reuters. Meanwhile, LBO shops have more money than ever to deploy, with fundraising volume rivaling or exceeding that of past quarters. Faced with an inability to do leveraged deals, the market is left to wonder when and how investors will renew their appetite for junk bonds.
Perhaps with an eye on the reviving corporate bond market, The
Meanwhile, others suggest that it will take some kind of trigger to bring back junk bonds. A number of factors could lead to a revived appetite for sponsor-financed high-yield bonds (see chart). Those factors include wider treasury-note rate spreads, which make the yield on junk bonds more attractive, along with a drop in default rates, which would calm investor nerves about the performance of speculative-grade debt.
For now, default rates continue to rise, and that alone might douse any spark of revival, according to Martin Fridson, CEO of high-yield research firm Fridson Investment Advisors. By the week of June 9, the global default rate on junk bonds hit a 31-month high of 1.45 percent, according to Standard & Poor’s. A rising default rate is historically accompanied by growing spreads between the treasury rate and high-yield bond rate. Still, if the spread between a high-yield bond and a virtually risk-free, government-guaranteed treasury bond isn’t wide enough, the former simply isn’t attractive for investors. “The consensus is that the peak [in defaults] isn’t coming until 2010,” Fridson said. Until then, one-off deals will get done, but vanilla leverage-reliant buyouts won’t, he said.
While they wait for interest in high-yield-backed buyouts to return, banks will continue to slowly cut away at their souvenir of the buyout boom, that $90 billion in unwanted hung loans. And in some cases, they’re selling it back to the very buyout firms that got them there.