Outlook 2011: High-yield primary market in year ahead not expected to top 2010's record issuance

By Paul A. Harris

St. Louis, Dec. 31 - Syndicate officials in the high-yield primary market are varied in their estimates for 2011 new deal volume, but all expect the tally of dollar-denominated deals to fall short of 2010's record-setting $292.6 billion total.

While one syndicate official expects as much as $275 billion of primary action in 2011, others see more modest totals in the year ahead. Issuance expectations among sources contacted by Prospect News ranged from $175 billion to $275 billion in 2011.

2010 set record

For the second consecutive year, the high-yield primary market set a new record for issuance.

However 2010, which saw issuers raise a record $292.6 billion in 657 junk-rated dollar-denominated tranches, buried the previous record notably deep.

The 2010 dollar total eclipsed 2009's $161.8 million, the previous record, by a whopping 45%; by comparison, that 2009 total topped the preceding record by only 1.4%.

The 2010 deal total, 657 tranches, topped the previous record, 2009's 381 tranches by 42%.

Nine of 2010's 12 months were the biggest respective months in market history.

September 2010, with $38.1 billion in 81 tranches, was the biggest-ever month for dollar-denominated issuance.

The past year also featured the biggest-ever week, in terms of dollar volume - the Aug. 9 week's $15.4 billion.

"A lot of the people in this market may be too young to remember, but the volume we were seeing in six weeks, this year, used to be what this market saw for a yearly total," asserted one veteran capital markets banker who has been working on high-yield syndicates since 1995.

Cautious issuance forecasts

Looking to 2011, the highest forecast for issuance was $275 billion, which came in a forecast range of $250 billion to $275 billion.

The lowest, $175 billion, came in a forecast range of $175 billion to $200 billion.

"The market can't continue to set new records, year after year" said the senior syndicate banker who offered the latter, lower forecast. "Something will happen - maybe in Europe - that will halt this onslaught.

"Since the market sloughed off Greece, we've been off to the races ever since. We hardly even took a break for Thanksgiving."

Having said as much, this official is looking for "a tremendous first quarter."

Elsewhere, syndicate bankers forecast $250 billion of 2011 issuance, although that figure, which surfaced in several conversations, was in two cases proffered as more of a hunch than a formal projection.

In each case, however, it came with the specification that such an issuance level, should it materialize, would be lower than 2010 issuance.

One investment banker forecasts $225 million to $250 million and reckoned the 2010 issuance total at $262.25 billion.

An underwriter projects $300 billion of 2011 global issuance, including exchange-adjusted non-dollar bonds. The 2010 amount of global issuance that this dealer tallied was $317 billion.

Europe and Canada

At least one European syndicate banker does expect 2011 European issuance to exceed that of 2010.

This official looks for €50 billion to €55 billion in 2011, versus the €44 billion that the source tallied for 2010.

"We expect things to pick up where the fourth quarter left off," the source commented, but added that credit events could interfere.

"A fair amount of uncertainty is baked into the market," the official reflected.

Also, volatility impacts the European high-yield market more so than it does the American market, the source added.

Another European syndicate banker said that 2011 ought to come close to 2010, in terms of issuance, and looks for €60 billion equivalent in total exchange-adjusted high-yield issuance from all European issuers.

Meanwhile, an observer of the Canadian high-yield bond markets expects issuance there to equal or slightly exceed 2010's C$3.4 billion during the year ahead (Prospect News saw a substantially higher amount of 2010 Canadian dollar-denominated high-yield issuance: C$5.76 billion in 15 junk-rated tranches).

Bank loan revival

One capital markets banker tempered his outlook for 2011 high-yield issuance due the expectation that some potential junk bond financings will be absorbed by the revived leveraged loan market.

"The high yield will still be doing more than its fair share, even though a lot of the refinancing has already been done," the banker said. "The event pipeline is going to make up for that.

"Volume will be consistent across both bonds and bank loans, but the bank market will pick up more than it did in 2010."

Mergers and acquisitions and sponsor-related financings will increase during 2011, said the banker.

And on this point there was broad agreement among all the sources who spoke to Prospect News during the run-up to the new year.

"Sponsors have been sitting on the sidelines," a senior syndicate official said. "Now things have improved to the point where they are going to have to become active again."

Biggest deals

Among the biggest deals in 2010, the biggest all-dollar transaction came during the first quarter when Frontier Communications Corp. completed a $3.2 billion issue of senior notes (Ba2/BB), a massively upsized (from $2 billion) four-part deal led by JPMorgan and Credit Suisse, which was priced on March 26, 2010.

The biggest global deal came in the fourth quarter from Italy's Wind Acquisition Finance SA. The telecom priced a €2.7 billion equivalent two-part secured notes transaction (Ba3/BB-/) via global coordinators Credit Suisse and Deutsche Bank, and joint bookrunners Banca IMI, Barclays Capital, BNP Paribas, Bank of America Merrill Lynch, Citigroup, Credit Agricole CIB, Goldman Sachs & Co., J.P. Morgan Securities LLC, Morgan Stanley, Natixis Bleichroeder, RBS Securities, UBS and UniCredit.

Mutual funds re-emerge

During 2010 the big mutual funds drove the market, according to a senior syndicate official who listed Pimco, Wamco, Franklin Templeton and Fidelity Mutual among the year's major players.

The hedge funds, which played significant roles as deal-drivers during 2006 and 2007, are for the most part shuttered or combined with other operations, the banker added. The ones that are still around are apt to put in much smaller orders than was the case back in '06 and '07.

"A couple of deals have struggled because they have been too small for the big mutual funds to deal with," the sellsider said. "But for the most part the deal size has gotten bigger and has allowed those mutual funds to get bigger chunks."

Because they have re-emerged as the market's preeminent investors, the high-yield mutual funds have been able to take control of their own destinies, as to how deals are structured, the official remarked.

"This was more apparent in 2010 than it has been in the past," the banker said.

Non-traditional buyside players, such as investment-grade funds, pension funds and insurance funds, were active in 2010.

However for the most part they tended to be active on the margins of deals.

"Insurance funds aren't what they used to be, in part because AIG, which was a big high-yield player, is a shadow of its former self," the official said.

"Some of the insurance companies - especially in the Midwest - are keeping their hands in. But they are not coming with the kinds of triple-digit orders that you get from Fidelity or Franklin."

Double B under pressure

The 2010 fourth quarter saw a dramatic upward move in Treasury yields, with 10-year government paper spiking to 3.55% in mid-December, after heading into the Thanksgiving weekend yielding 2.77%.

A high-yield investor chalked the big move up to the Federal Reserve Bank's second round of quantitative easing ("QE2"), which involves the central bank buying Treasuries, and to the two-year extension of the Bush tax cuts, which was hammered out by Congress and the Obama administration late in 2010.

Both of those actions are expected to generate upward economic momentum, making low-yielding low-risk investments, such as Treasuries, less attractive in comparison to securities such as stocks and high-yield bonds, the investor explained.

However, that decrease in popularity won't be isolated to Treasuries, market sources say.

Investment-grade corporate bonds and high-rated four B junk bonds will also "get whacked."

Jabil, for instance

One prime example of the travails of high-rated junk in a rallying market is the deal that Jabil Circuit Inc. did in late October 2010, sources say.

Jabil priced a $400 million issue of senior notes due in 2020 (Ba1/BB+/BBB-) at par to yield 5 3/8%, through the 5¾% area price talk.

Since pricing, those bonds slipped to 97½ bid, which reflects a yield of 5.96%, a source familiar with the deal said.

"Jabil was a solid four B issuer, and a well-followed name in the high-yield universe," the source related, adding that prior to coming into the market, the company's existing bonds were trading at 6 1/8% to 6¼%.

"But when they came there was a new issue discount, as opposed to a premium," the official recounted. "It was apparent that the company could do better."

So Jabil priced its bonds with a 5 3/8% yield, and they performed for a while in the secondary market. But as Treasury yields rose, Jabil's bonds have fallen.

The deal was certainly a good deal for the company, the source pointed out, and added that the bonds sold off for purely technical reasons having noting to do with Jabil.

"People just said `I can't own Jabil for Treasuries plus 140 basis points,'" the official reflected.

Greed and fear

Another syndicate banker, also reflecting on the Jabil deal, agreed that higher-rated Treasury-sensitive junk bonds face resistance going forward, "just because of rates."

Investors are looking for equities to come back to life during 2011, the banker added, noting that Morgan Stanley is forecasting a 10% return for the S&P 500 during the year ahead.

"Looking across the greed-fear spectrum, greed will probably outperform," the source asserted, adding that stocks and lower-rated high-yield bonds will outperform Treasuries, investment-grade bonds and high double B bonds.

"An improving macroeconomic outlook and declining defaults are going to help the lower rated stuff," the banker said.

The coupon-plus

The price appreciation that high-yield investors realized during 2009, and to a lesser extent during 2010, will likely not repeat in 2011, according to a money manager whose portfolio includes both junk bonds and stocks.

Thanks to rising Treasury rates and declining defaults, high yield is no longer cheap, the investor added.

"Spreads have really narrowed because Treasuries saw such a big correction in the fourth quarter," the buysider said, adding that during the pre-Christmas week the index traded at a 554 bps spread, down from 580 bps just after Thanksgiving.

"During the fourth quarter you saw a vast outperformance by triple C rated paper," the manager added.

"Right now single B and double B are separated by about 140 bps. That's modest, but it might be fair because defaults are supposed to be in the low single digits in 2011.

"The good news is that high yield is still a buy.

"The bad news is that the coupon is basically all we will get in 2011.

"There is a little room for modest capital appreciation - maybe 1% or 2%, overall."

Hence, if junk bonds yield 6% to 8%, that plus another 1% to 2% of capital appreciation should render a total return of 6% to 9%, the investor reasoned.

"That's not bad," the buysider commented.

"It's lower than the high-yield returns we have seen over the past couple of years. But with defaults so low, that should still be a good risk-adjusted return."

Neither the MGM bankruptcy in November 2010 nor the Great Atlantic & Pacific Tea Co.'s default in December took high-yield investors by surprise, the money manager said.

The Moody's Investors Service speculative-grade default rate declined to 3.5% in the 12 months which ended in November 2010, from 3.6% in October. In November 2009 the U.S. default rate reached 14.7%.

Among U.S. speculative-grade issuers, Moody's expects the December default rate to fall to 3.1% and to fall to 2.1% by the end of 2011.

© 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.