Outlook 2010: High-yield primary market could see $130 billion to $160 billion in 2010: survey

By Paul A. Harris

St. Louis, Dec. 31 - The year 2009 will be a tough act to follow for the high-yield primary market, market sources say.

Record new issuance in a market that generated greater-than 50% returns for investors and saw conditions move from a winter-spring deep freeze to the hot market conditions of summer and autumn, render 2009 a memorable year.

Still, syndicate bankers who participated in an informal survey generally expect $130 billion to $160 billion of high-yield issuance in the year ahead.

Record issuance

The past year saw record issuance in the high-yield primary market.

New issuance for the 12-month period that concluded Jan. 31, 2009 came to $160.114 billion in 380 junk-rated, dollar-denominated tranches, according to Prospect News data.

Until quite late in 2009, the previous record, 2007's $159.63 billion in 377 deals, appeared likely to remain intact.

The push to the new summit came on Dec. 18, the last day of actual activity in the primary market, when Clear Channel Worldwide Holdings, Inc. priced a massively upsized $2.5 billion two-tranche offering of eight-year senior notes (B1/B) at par to yield 9¼% - a deal that first hit the market sized at $750 million.

Meanwhile, 2009 euro-denominated issuance came to €21.145 billion in 43 tranches. Hence 2006's total of €29.599 billion in 74 tranches still stands as the record.

Forecasts issuance for 2010

Syndicate bankers generally look for issuance during the year ahead to be slightly more modest.

Most who participated in an informal survey expect $130 billion to $160 billion of high-yield issuance in the year ahead, although the ranges of the estimates varied.

The lowest estimate, $125 billion, came in an expected range of $125 billion to $135 billion.

The highest forecast number, $200 billion, came from one of the league table leaders who forecasted a range of $175 billion to $200 billion.

Mitigating factors apt to bear upon 2010 issuance totals include an expected regeneration of the leveraged loan market, which could draw proceeds away from high yield, and the direction of U.S. Treasuries.

A high-yield mutual fund manager in the Midwest, noting that U.S. Treasuries were yielding around 3.75% in late December, up 40 to 50 basis points in a month, said that should Treasury rates continue to push out, into the low-to-mid 4%-range, high-grade bonds will suffer as investors will be forced to take greater risks in order generate respectable returns.

This buysider added that insurance funds and pension funds appear to have not yet allocated as much cash to high-yield as they possibly could. The buysider believes that, given the right technical and fundamental backdrops, including rising Treasury rates, those players might allocate more cash to junk in the year ahead.

Some fixed income strategists, however, look for Treasury rates to rise for a time, in 2010, but then to fall, and ultimately end the year lower, as sluggish job growth and weak earnings weigh upon the U.S. economy.

Notably, in the run-up to year-end, two high-yield mutual fund managers each independently told Prospect News that, given the present technical strength of the high-yield market, fundamental economic weakness won't necessarily derail junk, at least during early 2010.

However, a syndicate banker counters that bad news, in terms of fundamentals, can - and most often does - change the technical picture quickly.

How far we came

Once the 2009 primary market regained its footing, in the spring, things moved rapidly, market sources agree.

As the summer came to an end, the market saw issuers and dealers becoming more aggressive with structures and uses of proceeds.

Through the end of September, 33% of new issuance was principally devoted to refinancing debt, while a paltry 0.4% was came to fund dividends, according to Prospect News data.

However from the beginning of October through the end of the year that picture changed dramatically. Deals principally devoted to debt refinancing fell to 17.5%, while dividend-funding deals grew to 2.6%.

"Last March, if someone told me we'd be financing dividends during the fourth quarter, I would have suspected they were nuts," admitted a Midwestern asset manager.

"But this is where we are."

Nor was this investor grinding his teeth about it.

The manager, in fact, played one of 2009's conspicuous dividend deals.

On Dec. 4, Quintiles Transnational Holdings Inc. priced a $525 million issue of 9½% senior notes (B3/B) due Dec. 30, 2014 at 98 to yield 10.012% via Morgan Stanley & Co. and Citigroup Global Markets Inc.

The Research Triangle Park, N.C.-provider of services to the pharmaceutical industry planned to use the deal proceeds to fund a $275 million dividend, as well as related payments to certain option holders of $8 million. Some $97 million of cash will be used to support PharmaBio's future operations and cash out its fractional shareholders.

"You are even starting to see transactions that are away from the plain vanilla deals," a senior high-yield syndicate official observed.

"The PIK toggle notes have returned, although hopefully there won't be too many of them," the banker added, pointing, in particular, to a late November visit to the high-yield primary from JohnsonDiversey.

On Nov. 20, one day after pricing a $400 million senior unsecured notes deal, JohnsonDiversey returned to the high-yield primary with $250 million of 10½% senior unsecured payment-in-kind notes due May 15, 2020 (Caa1/B-/) via Goldman Sachs & Co.

The PIK notes, which were issued by JohnsonDiversey Holdings, Inc., priced at 96.00, where the deal had been talked.

Proceeds were used to pay down Unilever's equity stake in JohnsonDiversey.

"You are seeing some exotic structures: bullet deals with maturities of less than five years, and five-year, non-call-three structures," the senior syndicate banker added.

"Earlier in the year there was an emphasis on bringing 'Center-of-the-fairway' deals, but lately we are seeing more flexibility, as the dealers attempt to meet the needs of the issuer, as well as of the investor."

Amazing they got it done

Another measure of the primary market's improvement was the ability of troubled companies to get deals done, sources say.

With respect to the above mentioned Clear Channel deal, one banker reminded Prospect News that the company had been rumored to be close to bankruptcy earlier in the year.

Early in 2009 the San Antonio broadcaster's debt was beaten up as it drew down the remaining $1.6 billion of its $2 billion revolver. The perception existed that Clear Channel was grabbing the cash while it could, in order to shore up its balance sheet.

Ten months later, of course, Clear Channel priced its massively upsized $2.5 billion deal (see above).

Another example of an "unlikely-before-the-rally" deal was MGM Mirage, a banker mused.

In early 2009 the Las Vegas strip's biggest casino operator, inhabiting a sector that was beaten down by the weak economy and needing to renegotiate terms on $7 billion of debt, was perceived as a bankruptcy risk, a banker recalled.

However in mid-May MGM Mirage priced $1.5 billion of senior secured notes (B1/B): $650 million of 10 3/8% five-year notes at 97.184 to yield 11 1/8% and $850 million of 11 1/8% 8.5-year notes at 97.344 to yield 11 5/8%.

Bank of America Merrill Lynch, Barclays Capital Inc., Citigroup, RBS Securities Inc. and Wachovia Securities were joint bookrunners.

More M&A ahead

Market-watchers expect 2010 to see a great deal more mergers and acquisitions-, LBO- and sponsor-related activity come into the high-yield market.

In 2009 acquisition financing accounted for just 5.5% of proceeds, while LBO deals amounted to just 0.77%, according to Prospect News data.

"We expected 2010 to look a lot like the fourth quarter of 2009," said a banker, who added that 67% of 2009's sponsor-related deals were transacted during the year's fourth quarter.

However a senior syndicate official, also expecting a considerable increase in sponsor-related activity during 2010, believes that 2010 won't be a return to the heady days of 2006, when a parade of highly leveraged LBO deals, backed by token equity, ended in a pile-up of hung bridge loans that sat for months on the balance sheets of the big dealers.

"The type of LBO financing which drove us to the brink is not going to come back any time soon, in the manner that we saw before the crisis," the banker asserted.

"There will be sponsor activity and LBOs. However the sponsors are not going to be able to dictate terms to groups of seven-, or even 10 investment banks."

This source, as well as another senior syndicate banker, said that with the consolidation which has taken place in the industry, with the disappearance of Bear Stearns and Lehman Brothers, and the absorption of Merrill Lynch and Wachovia Securities, the surviving investment banks are stronger, and hopefully wiser, and therefore won't be as easily driven into competitions resulting in unsustainable bridge financing terms.

"If the big deals do return you're apt to see the investment banks work together, as opposed to working against one another, as they did before the crisis," a syndicate official said.

"I hesitate to use the word, 'collusion,' but people are going to tend to arrive at a solution together, as opposed to bidding against one another," the source said.

Meanwhile a manager from a different syndicate was not quite as certain that the structures and terms of 2006 can be altogether kept at bay, should the high-yield rally carry on apace, into 2010.

"Look, if people want deals structured in ways that investors are willing to take, we'll structure them that way," the banker said.

"But the banks won't be keeping these financings on their own balance sheets for very long."

Kansas City Southern - How to identify pioneers

Apart from M&A, LBO and sponsor-related activity, there remains an impressive backlog of companies that still need to refinance debt, sources say.

In some cases, should the market remain hot, issuers might realize reduced costs of capital via 2010 high-yield refinancings.

However, in cases where an issuer got a great print, in 2005, with seven-year paper that comes due in 2012, that issuer will need to carefully weigh a certain refinancing opportunity against a possible increase in the cost of capital, one fund manager counseled.

The door for issuers may or may not remain open, the source added.

"You don't want to stand around and watch it shut while you are waiting for a possible cheaper cost of capital," the source said.

This source, as well as others, mentioned railroad company Kansas City Southern.

In late March of 2009, Kansas City Southern de Mexico, SA de CV sold a $200 million issue of 12½% senior unsecured notes due April 2016 (B2/B+) at 94.49 to yield a whopping 13¾%.

Onerous as a 13¾% yield might have seemed to the company, the deal came just three months after Kansas City Southern Railway Co. priced a $190 million issue of 13% senior unsecured notes (B2/BB-/) due December 2013 at 88.405 to yield 16½%!

Both transactions took place against the backdrop of turmoil in the credit markets, which reached its zenith in mid-September 2008 with the bankruptcy of Lehman Brothers.

And market conditions notwithstanding, Kansas City Southern needed to refinance its 7½% senior notes due June 15, 2009 at least three months ahead of that maturity date or breach its credit agreement, whereupon the lenders could force an acceleration of repayment.

One buyside source familiar with the credit said that Kansas City Southern might easily have doubled the size of the its $275 million issue of senior notes due June 2015 (B2/BB-/), which it priced at par to yield 8%, back in May of 2008, and use the extra proceeds to take out the 7½% paper.

However the company, perhaps anticipating continuing improvement of the high-yield market, elected to wait, and maybe realize an even lower cost of capital than the 8% rate it enjoyed in the May deal.

"As a result, they were over a barrel," the buysider recalled.

Shown a deal they could get done in December 2008 at 16½%, they had to take it because at the time there was no assurance that the market would even be open in early 2009 in time to forestall breaching the credit agreement.

"Kansas City Southern was forced to be a pioneer, and reopen a primary market that had pretty much closed down, after Lehman Brothers," a syndicate banker recounted.

"And you can usually spot pioneers because you see them walking around with arrows in their heads."

The lessons of Kansas City Southern won't likely be lost on potential issuers who need to refinance debt, market sources say.

Near-term to intermediate-term maturities are best dealt with while the market is open, even if the cost of capital is somewhat more expensive, they add.

As it happens, Kansas City Southern, itself a beneficiary of the lesson, will likely be back into the market to refinance its 9 3/8% senior notes due 2012, before the new year advances very far, a market source said.

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