Outlook 2015: High-yield primary market robust but tempered by caution on rates, energy

By Paul A. Harris

Portland, Ore., Jan. 2 – Before the phenomenal slide in crude oil prices got underway in earnest – a crash which saw the barrel price of West Texas Intermediate crude oil drop to $55.25 in late December from a high above $103 in June – the high-yield primary market for bonds churned at a near-record pace in 2014.

The first half of the year closed with $177 billion of dollar-denominated business having cleared the market, $40 billion more than the $137 billion that had been done in the first half of the record-setting year of 2012.

Even on Labor Day, with oil prices already slipping, 2014 new issuance was on a record pace at $206 billion, compared with $188 billion by Labor Day 2012.

In fact, heading into December, the 2014 primary remained on a record pace at $307 billion versus $298 billion at the beginning of December 2012.

However the 2014 primary market limped to the finish line.

December 2014 issuance came to just $7.4 billion versus the $26.7 billion that cleared in December 2012.

Hence 2014 finishes as the third biggest year in market history in terms of dollar-denominated issuance with $314 billion, $11 billion short of 2012’s record of $325 billion and also shy of 2013’s $323 billion tally.

Numericable/Altice a record

Nevertheless the 2014 primary market saw the biggest execution in the history of the market.

On April 23 affiliated European broadband and cable operators Altice Group and its 40% owned Numericable Group AG combined to bring new bonds to market, structured in two deals consisting of seven separate tranches, including four U.S. dollar-denominated issues totaling some $10.65 billion.

Overall the deal came to €12 billion equivalent of high-yield bonds in seven tranches and played to orders in excess of $100 billion equivalent.

The Numericable deal alone, at €7.9 billion equivalent, represented a record from a single issuer, according to one market source, who pointed to the TXU Corp. $7.5 billion hung bridge deal that came in October 2007 as the new runner-up.

The transaction was characterized as “groundbreaking” by sellside sources, who expressed the belief that it paved the way for more large-scale merger and acquisition financings to come with big high-yield components.

“The market showed us that it can take down a deal this size with no problem,” remarked one source close to the deal.

California Resources drops

However it was the California Resources Corp. $5 billion senior notes deal (Ba1/BB), which came in three bullet tranches that each priced at par on Sept. 11, that ultimately highlights the travails of the 2014 high-yield market at its troubled energy component.

It was a big liquid energy deal that was two-times oversubscribed, with the long tranche, the 6% senior note due Nov. 15, 2024, trading as high as 104½ bid before crashing to the low 80s late in the year due to collapsing crude oil prices, a trader recounted in the closing days of 2014.

2015 issuance forecasts

Forecasts for issuance in the year ahead almost all fall short of 2014’s $314 billion.

Barclays’ forecast is an exception.

The top end of its forecast issuance range, $310 billion to $330 billion, would top not only 2014 but would put issuance in record territory.

In a report to its clients, Barclays said that $315 billion of debt is set to mature and become callable in the next 12 months, a 25% year-over-year increase.

Barclays also looks for merger and acquisition financing to remain robust.

Both Citigroup Global Markets Inc. and J.P. Morgan Securities LLC forecast $300 billion of issuance for 2015.

Credit Suisse Securities (USA) LLC forecasts $260 billion.

BofA Merrill Lynch forecasts $210 billion.

In a note to its clients BofA said that its forecast represents a 10% decline from 2014. The forecast is shaped by the expectation that refinancings will drop by 20% in 2015, “as the hurdle rate for tapping the market becomes higher, given higher yields and lower expected maturities in the near future.”

BofA expects acquisitions to increase by about 10%.

January a big question

Dealers were working on a sizable pipeline of junk offerings intended to roll out in January, sources said.

However given a volatile mix of data at year-end it remained to be seen whether market conditions would accommodate that pipeline.

Possible January deals include Altice International and Altice SA with €5 billion equivalent secured and unsecured notes backing an acquisition, PetSmart Inc. with bonds to take out $1.9 billion of bridge loans, also an acquisition deal, and Travelport LuxCo with bonds to take out a $500 million senior unsecured bridge loan, in a debt refinancing.

However heading into year-end the mix of data was not rendering a very clear picture of what early 2015 might look like in the new issue market, according to a debt capital markets banker.

Factors creating the uncertainty included mixed cash flows to and from the dedicated high-yield funds as 2014 came to a close. The cash flows of the actively managed funds tended to be negative late it the year.

A tighter regulatory environment will create substantial hurdles for the deals structured with a lot of leverage, the banker added.

The looming expectation that 2015 could be the year that the Fed finally increases interest rates could also weigh upon high yield.

And continued pressure on the energy sector, due to the phenomenal fall and continued weakness in the price of crude oil – a sector that represents as much as 20% of the index – will certainly bear upon whether or not the market is able to digest a sizable calendar in early 2015.

2015 forecast returns

Forecasts for returns in high yield ran from 2% to 7%.

JPMorgan looks for a 7% return.

In a report to its clients JPMorgan characterized this return as “unspectacular” and said that negative forces at play in high yield, including uncertainty about oil prices and an expected increase in interest rates by the Fed are offset by a solid growth picture in which the U.S. consumer has more purchasing power because of lower energy prices, and an accommodative monetary policy on the part of foreign central banks, which should serve to help keep default risk historically low.

Credit Suisse looks for a 5% return in high yield for 2015.

Barclays forecasts that junk will return between 4½% and 5½%.

Citigroup’s outlook has junk returning 4½% in the year ahead.

Wells Fargo sees 3½% to 4½% returns in 2015.

Meanwhile BofA forecasts that 2015 returns will come in between 2% and 3%.

In a letter to its clients, BofA said “we find it hard to envision a scenario where investors earn coupon or above.”

BofA looks for loans to outperform bonds in the year ahead, in part because energy makes ups just 4.6% of the loan index, giving loans an edge should oil price volatility and weakness continue.

Defaults outlook

The default outlook for 2014 remains benign.

Barclays expects to see a default rate of between 2¼% and 3¼%.

In a report to its clients Barclays said that defaults were well contained in 2014, as broadly expected, and added that the 2015 rate should be no different, with default risk remaining subdued.

Both JPMorgan and Wells Fargo forecast 2½% default rates for 2015.

BofA looks for defaults to come in at 2% to 2½%.

Credit Suisse expects a default rate of 1% to 3%.

Europe in year ahead

Europe put up big numbers in 2014.

Euro-denominated issuance was a record €65.1 billion, according to Prospect News data, leaving the previous yearly record, 2013's €49.8 billion, in the dust.

Sterling-denominated issuance came to £9.8 billion in 2014, shy of the record £10.5 billion in 2013.

However as measured by euro-equivalent issuance, 2014 put up record numbers, sources said.

Credit Suisse reported that Western European high-yield issuance in 2014 was €110 billion and expects 2015 to come in even bigger at €125 billion.

Deutsche Bank, in a note to its clients, looks for European high yield to return around 5% in the year ahead and looks for issuance to remain on a par with that of 2014.

The European central bank is expected to start broad-based asset purchases in the first quarter of 2015, including corporate and government bonds, Deutsche Bank notes.

This will help European credit withstand some risks in the early months, not least from possible pivotal Greece elections.

However there will also likely be an early year drag from U.S. credit due to falling oil prices and fears of a hawkish Fed.

The European new issue market might face fewer headwinds than that of the United States, a syndicate banker said.

In addition to reasons stated above, the cash flows of the dedicated high-yield funds in Europe have been less dramatic and less negative than those of their counterparts in the United States, the source said.

The new year is expected to get off to a robust start when the above-mentioned Altice €5 billion equivalent offerings of secured and unsecured notes materializes.

That deal is expected in January, sources said.

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