KDP's Penniman cautiously hopeful for high-yield market comeback

By Paul Deckelman

New York, Aug. 20 - It's been a tough couple of weeks lately for the high-yield market, with the primary sector seeing several new deals pulled from the calendar and others backing up to higher-than-expected interest rate levels, while the formerly robust secondary market was taking its lumps as liquidity - as measured by junk mutual fund inflows - dried up. But the worst is probably in the rear-view mirror and the primary and secondary markets could be poised for a comeback, a respected market-watcher indicated Wednesday.

Kingman D. Penniman, founder and president of KDP Investment Advisors Inc. of Montpelier, Vt., said that with the withering of the formerly overloaded new-deal calendar - with many deals having now priced and others scrapped, such as Charter Communications Inc.'s $1.7 billion offering, postponed last week, and Oxford Automotive Inc.'s $240 million sale, heard pulled on Tuesday - the secondary market has a chance to regain its footing.

"Now we've seen the [primary] market pull back; last week we were anticipating $4.6 billion of financing and we got $2 billion and this week we priced one deal on Monday," Penniman told Prospect News. "I think that for the foreseeable future, this week and next week, unless there are some opportunistic drive-bys, depending on what the AMG data is, there's nothing coming to the market. And as a result secondary prices are starting to move up. So I think some of the price pressure we saw as a result of the primary market's exuberance has started to pull back."

Penniman noted that according to the daily index which his company compiles to measure the performance of the high-yield bond market, "as of last Thursday - for the first half of August - we were down 2.15% for the month, much worse than we were for July. As of today, we're probably going to be down 1% month-to-date. So the prices have started to come back as soon as the primary market dried up and Treasuries stabilized."

Penniman said that the junk market started to go south after half a year of robust inflows, an active new-deal market and strong secondary performance when people - new-deal investors and secondary players alike - "started to leave the high-yield market with concerns, first, about fixed income in a rising interest-rate environment, and second, that a lot of the hot money, the aggressive money, was leaving, knowing that they were seeing a new-issue calendar that was really working when interest rates were at their low in June and everyone was going to try and see one way or the other how they were going to get their deals done as quickly as possible.

"When you combine that with four weeks of negative cash outflows, then everything came to a crashing halt last week and the market just said ' no more,' and some companies decided [not to do their scheduled deals], given what they had to pay, given what was happening with the re-pricing of the secondary market. They pulled out voluntarily. Others just weren't able to come to market."

The KDP president is of the opinion that "a lot of these companies that postponed [new deals] because they didn't like interest rates where they were are going to have an opportunity to come back to the market in a more normalized environment."

Part of such a "normalized" environment would certainly be an end to the string of massive outflows from the junk bond mutual funds, which are closely watched as a key barometer of overall junk market liquidity trends. According to a Prospect News analysis of the weekly fund-flow numbers compiled by AMG Data Services of Arcata, Calif., in the past four weeks, the funds have hemorrhaged a net total of approximately $4.91 billion, including outflows of over $1 billion in each of the last three weeks.

But Penniman - mirroring sentiments expressed by some high yield secondary traders, who've noted the upturn in market performance over the past week - believes that the nearly month-long losing streak could come to an end.

"I definitely think that the technical tone of the market - where we're starting to see on a daily basis that the market opens up and there's activity in the morning - though not anywhere near the [previous] level of activity, both in terms of money changing hands and the number of participants - has a lot of bonds across the board rising a lot more than one-half to a point.

"We saw the same thing again today, where we saw some of the issues that had been hard hit rising two or three points. Basically the tone of the market is one of very few sellers and people out there looking to see what they can buy, so you're watching prices move up. "

What that means, he says, is "that would probably be indicative that the AMG data is either going to be less onerous than it has been or, in fact, could be a positive number. The prices rising tells you that somebody has money to put to work, and there's nothing in the primary, so secondary prices are rising on a selective basis."

Assuming that the market starts to normalize, in terms of a return of liquidity and a stabilization of interest rates, does that mean where headed for a revival of the kind of euphoric primary and secondary markets seen during the heady weeks earlier this year?

Probably not, Penniman says, noting that "I think it's a question of where people think we are with the economy and where we think interest rates are going to go. If we start to see normalization of interest rates, then some of the pressure on the secondary was overdone and it depends when people find that [the secondary market is ] attractive.

"But we're not going to see the kind of activity we saw in May and June in terms of so much money coming that people didn't care and tried to buy everything they could buy. I don't think it's going to be that kind of gold rush again for the underwriters and the companies that were hoping to get as much financing as possible. You definitely are going to see an active market - but it won't be that kind."

The kind of "timer money" that seemed to be driving much of the upturn in the first half is in all probability gone, Penniman asserts, although he allows that "as we've seen before, it can leave one week and then all of a sudden come back and then some more two weeks later."

A more likely scenario, though, is that rather than having an overload of opportunistic "hot" money coming in and driving things, once liquidity concerns and interest rates start to mitigate, "I think we'll see better balance, and with better balance we'll see some of these prices recover, and high yield is still an attractive place to be, especially longer term" - and especially relative to "a lot of other fixed-income asset classes that are going to be hurting."

St. Louis-based cable operator Charter's failure to get its high-profile $1.7 billion financing deal done last week was the culmination of several weeks of negative market developments and was clearly a large setback for an already reeling junk market.

But once things calm down, Penniman projects: "We think the company is going to attempt to come back [to the market] - but this time in a series of steps, including asset sales. But in the interim, the company has a problem and I think part of the problem is they're going to have to do it in steps instead of coming [to market all at once]."

The investment advisor believes that the market "now reflects this. We feel this failed refinancing certainly increases the event risk of the company and we revised downward our credit opinion of the company."

He says that the market now "is a lot different" than when Charter proposed its mega-deal and the accompanying bond tender offer back in mid-July. "Now, people are looking at refinancing of critical-care credits in a very different light."

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