Junk Pipeline Offers Glimmer Of Hope

More junk bonds were issued this past May than in any other month since June 2008, a sign that lenders are starting to become more comfortable with risk. Some sponsor-backed issuances in particular, such as those from Apria Healthcare Group Inc. and Harrah’s Entertainment Inc., could be harbingers of an impending thaw of the frozen credit markets.

Nearly $12 billion of high yield debt was raised in April by public and private companies based in the United States, more than four-times the amount raised the month before. In May, U.S. companies raised even more, issuing more than $15.9 billion in speculative bonds, nearly tying the trailing twelve-month high of $16.3 billion, which was raised in June 2008, according to data obtained from Standard & Poor’s Leveraged Commentary and Data.

On May 27, casino and hotel operator Harrah’s Entertainment, which is backed by Apollo Management and TPG, issued $1.3 billion in 12 percent high yield notes due June 2017. What’s noteworthy about the deal is that—not only did the company pull in well more than the $1 billion it originally set out to raise—it did so despite the fact that the notes were marked with the lowest ratings of any other recent high yield offering, a sign that at least some investors are ready to take on more risk. Harrah’s Entertainment’s offering was rated ‘Caa3’ by Moody’s Investors Service and ‘B’ by S&P.

The few sponsor-backed issuances that have gotten done this year have, for the most part, been rated at the higher end of the speculative-grade spectrum by Moody’s and S&P, typically in the B1 and BB ranges respectively.

Martin Fridson, CEO of investment management firm Fridson Investment Advisors, told Buyouts the low-rated Harrah’s issuance could set a new benchmark for how much risk investors are willing to take on after being inundated, for the most part, by higher-quality deals.

“Procedure for underwriters, when they are coming out of a period of very little or no issuance, is to start out with the very top-tier credits with the most attractive terms in the best industries, and then gradually branch out from there,” Fridson said. Typically the deals get riskier and riskier until the market balks, which obviously was not the case with Harrah’s Entertainment.

Elsewhere, on May 21, The Blackstone Group’s Apria Healthcare sold $700 million in 12 percent notes due 2014 in order to repay a $1 billion temporary bridge loan that was issued to finance the company’s $1.7 billion take-private transaction in October. The deal, which was rated ‘Ba2’ by Moody’s and ‘BB+’ by S&P, stands out because it was the first sponsor-backed issuance of the year used to replace temporary LBO financing with a longer-term structure. If bridge loans of recent LBO deals are being paid down by high yield, an argument can be made that it may not be long before new acquisitions are once again directly funded through high yield issuances.

Indeed, Gibson Energy Holdings Inc., a portfolio company of Riverstone Holdings, issued $560 million in 12.5 percent notes due 2014 to repay the bridge loan used to fund the company’s buyout from Hunting Plc in August 2008. That deal, too, closed on May 21, and was rated ‘B1’ by Moody’s and ‘BB-’ by S&P.

The prospect of high yield debt being used to fund new LBO deals is all the more plausible given the results of a recent survey conducted by the National Association for Business Economics Outlook, which found nearly three quarters all participating economists believe economic growth will begin to rebound sometime in the second half of the calendar year.

In May, the high yield default rate hit a year-to-date high of 8.25 percent, up from April’s 6.75 percent, according to a June 1 report issued by S&P. In a somewhat dour forecast, the ratings agency predicts a 14.3 percent default rate by April 2010 with a worst-case scenario reaching as high as 18.5 percent.