Outlook 2014: The year ahead - A big January, and then...

By Paul A. Harris

Portland, Ore., Dec. 31 - The year ahead in the high-yield primary market should begin at pretty much the same pace at which the old year left off, sources say.

Look for a big January.

However market sources tell Prospect News that the year ahead could ultimately see a lesser amount of issuance than the back-to-back record-setting years of 2012 and 2013.

Forecasts ranged from a low of $200 billion to a high of $300 billion.

In a note to clients, BofA Merrill Lynch professed the expectation that issuance would decline by 10% to 15% in the year ahead.

BofA cited the expectation of rising interest rates and a declining amount of potential refinancing issuance in the pipeline and projects U.S. issuance of $220 billion to $240 billion for 2014.

JPMorgan is more bullish.

In a note to its clients JPMorgan said that despite rising interest rates, capital market conditions for high-yield issuers are expected to remain robust, and forecast issuance of $300 billion in the year ahead.

Among the factors it cites are continuing low defaults in the high-yield universe.

JPMorgan forecasts that defaults will remain below 2% during the year ahead, considerably below the long-term average of 4%.

A look back

In 2013 the primary market posted a new issuance record, but just by a nose.

The 2013 total, $327.85 billion in 701 junk-rated, dollar-denominated tranches, outdistances the former record, 2012's $327.06 billion in 691 tranches by $791 million, and by 10 tranches, in terms of deal volume.

The biggest month of 2013 was May, which saw $46.17 billion in 102 tranches.

The biggest week was the week starting Sept. 23, which saw $17.18 billion of issuance in 28 tranches, including megadeals from General Motors Co., which priced $4.5 billion in three $1.5 billion non-callable tranches, and Dell International LLC (Denali Borrower LLC and Denali Finance Corp.) which priced $1.5 billion 5 5/8% notes due Oct. 15, 2020.

The slowest 2013 month was June which saw $13.62 billion in 35 tranches.

Apart from the first week of the year, during which only one deal priced, the slowest week was that of July 8, which saw $1.56 billion in eight tranches.

The average monthly issuance was $27.3 billion, and the average monthly deal flow was 58 tranches.

The average weekly issuance was $6.3 billion, and the average weekly deal flow was 13 tranches.

The can has been kicked

In 2013 a full 46% of issuance came to market for the exclusive purpose of refinancing debt. That does not count deals in which debt refinancing appeared as only a partial use of proceeds.

Deals that came exclusively to fund mergers and acquisitions and leveraged buyouts made up just 14.5% of the 2013 total.

That may need to change in the year ahead because many issuers in the high-yield universe have already addressed their near- and intermediate-term maturities, sources say.

Hence refinancing deals should diminish somewhat.

Risk aversion eroding

As has been the case in three of the past four years in high yield, the more risk you took on in 2013, the better you made out, one investor recently observed, citing JPMorgan's high-yield index.

The triple C ratings class returned 14.1% in 2013, whereas single Bs returned 8.1% and double Bs returned only 3.8%.

Hence the appetite for aggressive deal structures, such as PIK toggle notes to fund dividends, went up in 2013.

PIK notes, which comprised just 1.75% of 2012 issuance, jumped to 2.6% of issuance in 2013, a 49% increase.

Massive amounts of cash looking for a home in the high-yield asset class eroded risk aversion in 2013 and are likely to continue to do so in the months ahead, a debt capital markets banker said.

Europe awaits a big January

Whereas 2013 issuance in the dollar markets overtook the previous record by a nose, European high yield issuance vastly eclipsed the previous record.

European issuance came in more than 27% higher than that of the next-highest yearly amount, according to a sellside source.

Issuance in 2013 was $104 billion equivalent, versus 2010's $81 billion equivalent.

Issuance in the year ahead is expected to be close to the 2013 amount, but is unlikely to top it, the sellsider said.

January should be a big month in the European high-yield new issue market, as the biggest issuers are going to want to get ahead of anticipated interest rate increases.

However new issue activity is expected to remain vigorous throughout the year, in part because the smaller issuers will likely continue to remain inclined to term out higher rate bank debt with bonds.

As with the U.S. market, credit quality - which slipped in 2013, and the euro market, which saw a historic amount of PIK toggle issuance during the past year, for example - could continue to decline as investors come to grips with the notion that in order to achieve the kinds of performances they are looking for they will need to get under more risk, the source added.

However, the European market is unlikely to see PIK toggle deals come with seven-handle - and even 6-handle - rates as was the case in the 2013 dollar-denominated new issue market.

Nevertheless, a sea-change in credit quality took hold of the euro market in 2013, the banker said.

Whereas historically two-thirds of euro-denominated issuance was double B quality, the situation reversed in the past year, with roughly two-thirds of 2013 issuance coming with ratings below double B.

That could point the way ahead, the banker said.

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