Barclays sees junk as 'increasingly attractive,' expects more supply

By Paul Deckelman

New York, June 23 - The recent backup in spreads has made the high-yield arena "increasingly attractive" in the view of Barclays Capital. The big investment bank, whose research department released its near-term outlook for various classes of investment vehicles on Thursday, also raised its forecast for likely junk bond issuance this year by about 20%. The increase was driven by the expected continued wave of debt-refinancing deals.

Barclays' head of research, Larry Kantor, told members of the financial press that financial markets generally have "backed off" over the last few months amid investor worries about all kinds of macroeconomic developments, including the continuing debt problems in Greece and the contagion threat they might pose to other weak European economies, rising oil prices triggered by political upheaval in the Middle East, a generalized economic slowdown in the United States and elsewhere, the lingering effects of the earthquake-tsunami disaster in the world's third-biggest economy, Japan, and nervousness over the U.S. deficit and debt-ceiling situation.

Even Barclays - which, he noted, was the first major bank to "get bullish" following the 2007-2008 financial meltdown, counseling investors in March 2009 to overweight riskier assets - pulled in its horns a little earlier this year, advising in March a move from overweight in the riskier assets to neutral. But with that change out of the way, it is recommending that investors now "stay the course" and not pull back any farther. "We see the current market correction as having opened some tactical opportunities," Kantor declared.

No blowups seen likely

While there is no quick and easy solution for either Greece's problem or the U.S. long-term financial mess, Barclays is firmly convinced that there will be no near-term catastrophic "blow up" from any of the negatives, barring anything completely unforeseen.

While Greece will have to restructure sooner or later, it is likely to "kick the can down the road" for now, Kantor said, and receive enough temporary help from the other European powers and the International Monetary Fund to allow Athens to continue paying its bills.

In Washington, Barclays believes that congressional negotiators will, at the end of the day, approve an increase in the debt ceiling, although things may go down to the wire before the Aug. 2 deadline and the increase will not be as large as the White House would like, meaning a likely return to the bargaining table for another round of brinksmanship, possibly even later this year. "If push came to shove and they didn't pass this," Kantor said, "they'd choose to cut spending somewhere else." He flatly predicted that "there's virtually zero chance that they actually default and don't make the [Aug. 2] payment."

The research chief, who is also a managing director of the company, said, "We agree with [Federal Reserve chairman Ben] Bernanke that you're going to see better growth in the third quarter in the U.S. and, more broadly, globally." He added that an improvement in growth plus a calming down of the Greek default fears "offers a little bit of a buying opportunity here because sentiment has been so negative about these things."

Spreads make junk attractive

While Barclays is very bullish on equities, believing that valuations "remain reasonable in absolute terms and cheap relative to both cash and bonds," it is also positive on high yield. Kantor asserted that "spreads have gotten wide enough now in this recent bout of risk-aversion that our credit guys think it's time to put some risk on here. I think they especially like high yield, because high-yield spreads are now the widest levels they've been this year, and they see some attractive areas like financials, for example."

Another Barclays managing director, Barry Knapp, who is the head of U.S. equity strategy, said, "From an investment-grade credit and high-yield perspective, spreads have widened enough that so that even if you get a backup of 50 basis points or so in Treasuries, you'll still wind up with decent returns."

As a result of the recent macroeconomic worries and also the liquidation of portfolio assets related to the Maiden Lane limited liability companies created by the Federal Reserve Bank of New York in 2008 to buy up risky assets connected with the collapse of Bear Stearns and the problems of American International Group, Inc., Knapp said that "people even started selling high yield as a hedge and spreads widened quite a bit." But, he said, 'those markets now are cheap" - not cheap relative to equities, but still cheap enough to be attractive.

Catch a rising star

In making its recommendations to investors, Barclays urges them to be "seeking out potential rising-star BB names and refinancing candidates." They should particularly look for lower-dollar-price potential financing situations and merger and acquisition possibilities that could result in tenders for those bonds.

While it generally likes fixed-income financials, it makes an exception for European high yield, where "we continue to prefer single-B non-financial paper in addition to BB rising stars." The single-B European non-financials represent "an attractive balance of credit quality and relatively high yields."

In its Thursday report, Barclays noted that junk market yields to worst have pushed up to around the 7½% level after reaching an all-time low of 6.6% earlier in the second quarter. Year-to-date returns on its U.S. High Yield index, after notching impressive gains earlier in the year as returns were pushed forward by falling yields, have lately been on "a protracted losing streak," which dropped the year-to-date figure down to about 4.5% as of mid-June. Credits with BB and CCC ratings outperformed the overall index, at 4.8%, while the single-B names lagged behind at 3.9%

More strong issuance to come

Looking at the junk primary sphere, Barclays noted that gross new issuance through mid-June stood at $162 billion, running about 60% ahead of last year's pace, which itself was a record-breaker. About two-thirds of the new paper was used to refinance existing debt, roughly evenly split between refinancing loans and bonds.

Besides the relatively low yields that made the first half of the year an attractive time for issuers to bring deals to market, "the deluge was due in part to the large quantity of bonds that were approaching their first call dates" during the first half, Barclays said, adding that this should be "similarly large" in the second half. With yields still "quite low by historical standards," and assuming they stay that way, the heavy volume of refinancing situations should produce new issuance of between $110 billion and $130 billion. On top of a first-half total, which should come in around the $165 billion-to-$170 billion range, Barclays projects full-year issuance of between $275 billion and $300 billion, "which would be a third straight all-time record."

Besides seeing refinancing continuing to be the main driver of junk bond issuance, Barclays noted that the breakdown for uses of proceeds remains about unchanged from last year, even with "a pickup in absolute levels in M&A and [leveraged buyout] activity relative to 2010." As was the case last year, bonds being sold to fund mergers and acquisitions or LBOs represented just under 20% of all deals, while capital expenditures and general corporate purposes deals were just over 10%.

The bank further noted that in the smallest categories, deals to fund dividends and share repurchases were up only slightly, and those funding exits from bankruptcy fell to just above zero.

Secured issuance - which had accounted for 34.0% of new junk bonds in 2009 and 27.2% in 2010 - has fallen to just 22.7% of this year's total to date "as issuers have found it increasingly easy to control deal terms as market conditions have improved."

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.