B of A: New issuance lags last year but shows good execution; fallen angels sizable factor

By Paul Deckelman

New York, March 5 - New high-yield issuance is running well behind year-ago levels, according to data compiled by Banc of America Securities - but the deals which are being done are frequently upsized, and almost all price at or inside pre-deal market price talk. The investment bank's study also shows that issuers which became fallen angels in 2001 account for a hefty 30% of this year's new issuance so far. The busiest new-issue sector of a year ago, telecommunications, has given way to a new king - media and entertainment.

In a new investment report, B of A said that from the beginning of the year through Feb. 27, 36 issuers had brought a total of 38 new U.S. dollar-denominated high yield issues to market for total proceeds of $10.364 billion - just 53% of the $19.778 billion par amount which had priced by that time a year ago, when 52 new issues had made their debut (although the report notes that the 2001 January-February period featured atypically heavy issuance, following an unusually severe issuance drought in the 2000 fourth quarter). With first-time issuers accounting for almost one-third of the total number of issuers in the dollar-denominated market in 2002, the average size of transactions dropped from $380 million for the 2001 period of Jan. 1-Feb. 27, to $273 million during the comparable period this year (with slight variations due to the differing methodologies involved, these year-to-date figures are roughly consistent with cumulative data compiled by Prospect News and reported in Monday's edition of The Prospect News High Yield Daily).

However, the B of A analysts noted, "strong investor demand [in the 2002 January-February period] has led to favorable executions for borrowers. This is evidenced by the upsize of approximately 50% of the new issues (one-third of which grew by at least 50% in volume), strong price execution (over 95% of the transactions priced within or through the price talk), and favorable absolute yields (average yield of 9.8% in 2002 versus 10.2% during the same period in 2001)."

Paradoxically, the credit quality of the new issues would seem at first glance to have lessened in the latest period, when single-B credits accounted for 31 of the 38 new issues which priced; their combined volume of $8.5 billion represented a whopping 82.1% of the 2002 year-to-date new issuance volume, compared with just 51.7% in January-February 2001. Conversely, BB issues have shrunk to just 16.2% of this year's new issuance, less than half of the 37.8% a year earlier.

But according to the report, this is not a negative - but in a curious way, a sign that investors believe the worst is over and are willing to tolerate more risk. It explained that the record high volume of defaults in 2001 "seems to have made investors more cautious through 3Q01 in their primary, as well as secondary, investment selections. The rise in B-rated issues since 4Q01 may be a signal that the market is returning to its normal levels."

But primary investors aren't completely ready to throw caution to the winds and return to the way things were before the default barrage; the bank's figures show that issues rated CCC and below comprised only 1.7% of the new issuance in January and February of 2002, versus 7.13% a year earlier, and while unrated issues - usually an indicator of suspect credit quality - comprised 3.4% of the bonds issued in the first two months of 2001, no such issues priced in the equivalent time period this year.

Also on the subject of credit quality, the B of A study noted that new issuance by fallen angel credits - those which have been pushed down into speculative grade territory from investment grade by both the major ratings agencies - has played a "prominent" role in this year's new issuance so far. It enumerated that through Feb. 27, five fallen angel issuers - Xerox Corp., Solectron Corp., Owens-Brockway Glass Container Inc., PanAmSat Corp. and Longview Fibre Co. - had priced $3.115 billion of new high yield issues - fully 30.1% of the total year-to-date new-issue volume.

What are issuers using the proceeds of their bond sales for? Given a dicey economic environment in which many companies have curtailed capital expenditures and have put other forms of business investments into "a holding pattern," refinancings and repayments of existing bank facilities "have consumed the lion's share of this year's new issue proceeds."

Refinancing and repayment transactions accounted for approximately 84% of total U.S. dollar-denominated new-issuance volume in the first two months of 2002, up from 69% during the same period in 2001. The second-largest use of proceeds in 2002 has been acquisition funding, which accounted for 12% of the year-to-date new-issue volume (one leveraged buyout transaction - TSI Telecommunications Inc. - accounted for approximately 2% of this year's new-issue volume through Feb. 27; the company sold $245 million of 12¾% senior subordinated notes due 2009 on Feb. 5). Recapitalizations also accounted for 2% of this year's new-deal volume through Feb. 27.

By way of contrast, 15% of the proceeds of January-February 2001's new high yield deals went for capital spending - a category which, has noted, has been virtually eliminated so far this year. The funding of acquisitions accounted for 9% of the proceeds use, and 7% went for general corporate purposes.

From an industry perspective, media and entertainment has been the most active sector in the high yield primary market in 2002 through Feb. 27. Although the sector's total proceeds are considerably lower so far this year than they were at the same time last year (falling to $2.357 billion this year from $3.973 billion a year ago), they rose as a percentage of total issuance for the two-month period to 22.7% from 20.1%.

The busiest sector for new issuance early last year had been telecommunications, accounting for $6.11 billion of new bonds, or fully 30.9% of the total sold in the two months, but with the telecom industry now on the rocks - many high yield telecom issuers are either bankrupt or undergoing some other form of restructuring - those numbers have undergone what B of A termed "a significant drop" to $1.345 billion so far this year, or 13% of the total.

So far this year, two other sectors besides media and entertainment have supplanted telecom on the list of the largest-issuing sectors; capital goods/ manufacturing ($1.8 billion, or 17.4% of the new-issue total) and basic materials ($1.515 billion, or 14.6% of the total). In the year-earlier period, these sectors had been largely ignored, with capital goods accounting for only about half of this year's two-month issuance total at $950 million (4.8% of the cumulative total) and basic materials for $1.575 billion (8% of the total). Gaming and lodging issues continued to account for a relatively steady percentage of the new issuance, although the overall number is lower in the first two months of this year ($1.035 billion, or 9.99% this year, versus $1.88 billion, or 9.5% a year earlier).

Looking ahead, the Banc of America analysts concluded, "we see a moderate, but growing, backlog of transactions" as the market moves into March. "Given [last] week's testimony by Chairman Greenspan (and the equity markets' favorable reaction since his remarks), prospects for a recovery during the second half, and investors' strong cash positions, our outlook for the 2002 new-issue market remains favorable."

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