High-yield market suffering winter chill in August, S&P report says

St. Louis, Aug. 29 - While the broad-based measures of credit market performance remained fairly stable in August, the high-yield market succumbed to a deterioration in credit market conditions from fears over subprime exposure and accentuated hedge fund liquidations in related areas, according to "U.S. High-Yield Prospects: Winter In August Sends Chill," a report released Wednesday by Standard & Poor's.

In the report, managing director Diane Vazza and her colleagues note that even though problems did not specifically emerge from high-yield credits, the junk market underwent a broad repricing of risk that occurred as investors were forced to sell liquid assets to cover losses on illiquid ones.

In response, spreads on junk bonds blew out to 455 basis points on Aug. 20, which was 37 bps wider than at the end of July and 186 bps more than three months earlier.

Both the CDX High Yield 8 and CDX Investment Grade 8, which maxed out at 528 bps and 81 bps, respectively, have tightened over the past few weeks, the report noted.

As of Aug. 27, the CDX High Yield 8 was trading at 385 bps and the CDX Investment Grade 8 was at 62 bps, still exceptionally wider than at the end of May when the indices closed at 258 bps and 34 bps, respectively.

The report also noted that the high-yield new issue market has been frozen, with few deals being done since the end of June.

"The red-hot leveraged loan market has also cooled, leaving many deals still on the forward calendar or abandoned altogether. Investors, however, have clamored for high-grade paper, as inverse inquiries have helped prompt $51 billion in bonds rated by (S&P) to come to market in August," the report said.

"With risk appetite diminished, we expect that riskier speculative-grade firms will have trouble accessing credit markets until investors warm back up to risk. However, outlandish leverage levels are likely to receive much greater scrutiny even after the market stabilizes."

Volatility in the credit markets significantly slowed the previously red-hot leveraged finance market in July and August.

High yield, which saw meager issuance in July and less in August, is still well above the year-to-date total of the past few years. Meanwhile, investment-grade activity, which slowed significantly in July ($32 billion of issuance), has picked up in August, with $51 billion in bonds coming to market.

However, investment-grade issuance is off its monthly average of $92 billion based on the first half of the year, though July and August are historically two of the slowest months.

Leveraged loans, which averaged $62 billion a month through June, slowed to $29 billion in July, as LBOs were practically halted.

"New loan deals are stalled because of the lack of investor interest because secondary prices are more attractive. There is still a large backlog of deals and a heavy forward calendar; so when credit markets do warm up to leveraged issues, we expect a rush of issuers looking for financing," Vazza and her colleagues reported.

"For underwriters, risk has risen because they are being forced to hold billions in unsold loans. A drop in the value of these bridge loans could hurt banking profits significantly, which will only exacerbate the credit woes in the leveraged finance market. Unless investor sentiment turns around quickly, we expect banks to be circumspect about underwriting new speculative-grade paper and that firms with low-credit quality to be shut out of the market temporarily."

In the face of volatility in the credit markets, some of the measures of high-yield performance have remained fairly stable, S&P noted, adding that its speculative-grade default forecast remains at 1.4% by year-end 2007.

"Large leverage multiples among many speculative-grade firms and high issuance at the B- and below rating level has increased the market's default pressure," Vazza and her colleagues wrote.

"However, we expect a fairly slow pace for corporate defaults for the rest of 2007, as structural concessions could push some potential defaults into the next year. The main risk to this forecast is that defaults could be at a more rapid pace, especially if firms' inability to access credit markets is prolonged beyond a reasonably expected term."

The report also provides a list of companies that may need to refinance high-yield bonds during the remainder of 2007:

* Briggs & Stratton Corp. (BB+ stable);

* Newfield Exploration Co. (BB+ stable);

* The Gap Inc. (BB+ stable);

* Sears Roebuck Acceptance Corp. (BB+ negative);

* Bausch & Lomb Inc. (BB+ negative);

* AAR Corp. (BB stable);

* CSC Holdings Inc. (BB negative);

* Lamar Media Corp. (BB- stable);

* International Shipholding Corp. (B+ stable); and

* Univision Communications Inc. (B).

Vazza and her colleagues commented that given the lockdown in the high-yield bond market, speculative-grade firms may have to find other sources of financing, at least temporarily:

"Three months ago, a firm in the same situation may have only had to pay a slightly higher risk premium. Today, that may be enough to shut them out of the bond market, which could lead to intensifying default pressure for lower rated firms, in the near-term at least."

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