Deutsche Bank: Junk issuance pauses amid volatility, Fed uncertainty - but market still has promise

By Paul Deckelman

New York, June 18 - High-yield new issuance has been running at red-hot record levels this year - up until now.

With increased market volatility over the past few weeks in the wake of indications that the Federal Reserve may decide to soon start tapering off on its expansive quantitative easing policy that has kept interest rates low and the credit markets supplied with ample liquidity - and the Fed is scheduled to give an update on its thinking on Wednesday - volume has dropped off sharply, and several deals which were being shopped around have either been postponed or pulled altogether.

That having been said, senior market watchers at Deutsche Bank are still constructive on the junk sector, as well as other segments of the fixed-income markets in the United States such as leveraged loans and high-grade corporate bonds.

In the current environment of relatively low default rates and an economy that is expected to meander around for a while with annualized growth rates no higher than 3% tops, "high yield should perform well against other asset classes," said Kevin Sherlock, the head of loan and high yield capital markets for the German banking giant's North American division.

Hot issuance pace cools off

Sherlock and several other senior Deutsche Bank executives spoke to reporters Wednesday on the state of the U.S. corporate finance markets - and one of the key takeaways vis a vis the junk market was that right now issuance seems to be in a holding pattern.

They noted that last month's $46 billion of new U.S.-dollar-denominated junk-rated paper was the most ever for one month, topping the heaviest issuance months of years past.

According to data compiled by the bank accompanying the presentations by Sherlock and his colleagues, last month's issuance edged out the roughly $45 billion that came to market last September, the previous record holder. So far this year, new issuance for the first five months of the year totaled $165 billion - well above the $134 billion which got done from January through May of 2012.

This year's issuance had been on pace to surpass 2012's full-year tally of $334 billion - but that pricing parade has slowed down markedly in June, with just $4 billion having priced in the first part of the month, Deutsche said.

The bank held out the possibility that this month's total may not even be able to top the $9 billion that priced in June 2012, when issuance had fallen off dramatically from the previous month amid concerns about the deteriorating credit situation in Europe that was roiling the markets over there at the time and frequently spilling over to equity and debt markets on the other side of the Atlantic. There were also some concerns in the financial markets at this time last year about the continued inability of the U.S. to make any meaningful deficit reduction progress and the looming threat of a possible U.S. sovereign ratings downgrade, which in fact finally did come to pass early last August.

Things in Europe have been a little quieter this time around, since the apparent resolution of the financial crisis in Cyprus some months back and U.S. debt and deficit worries have been put on the back burner for now - but even if that wasn't the case, according to Tom Joyce, a managing director and capital markets strategist with Deutsche's Capital Markets and Treasury Solutions group, it wouldn't make much difference.

The domestic capital markets "are trading differently this year than they have been in prior years," Joyce told the press briefing. "They're much more resilient to macro risks - of course, they're much more sensitive to central bank policies, but they're much more resilient to macro risks, so we can have fiscal cliff issues and Cyprus events and Italian elections and so forth, and our funding markets in the U.S. are absorbing that much better. That will continue - we are not expecting or concerned about the debt-ceiling risk in Washington in October or November. I think that's going to work itself out and not impact our funding markets in the way it has previously."

Market warily eyes Fed

Of more immediate importance to junk and the other capital markets are concerns over the likely start to the Fed's winding down of its current QE3 quantitative easing program, under which the central bank has been purchasing some $85 billion a month of Treasuries and mortgage-backed securities.

Remarks by Federal Reserve chairman Ben Bernanke last month to the effect that the central bank might cut the pace of those security purchases in the next few meetings, depending on incoming economic data, were seen as the principal catalyst for the more than 50-basis point backup in the benchmark 10-year Treasury note's yield from the recent lows it had hit earlier in May. That in turn caused turmoil in both the equity and debt markets, particularly in Junkbondland, in late May and early June. Average junk yields have risen by more than 100 bps from their early-May lows of just under 5% and high yield's year-to-date returns have been almost halved.

Sherlock noted that higher-quality, more interest-rate sensitive junk bonds, such as BB-rated credits, "have actually sold off more than the 10-year [Treasury] has.

"What has bothered the high-yield market more than the absolute increase in the 10-year [yield] is the pace of the increase in the 10-year," whose yield shot up dramatically from just above 1.60% on May 2 to just under 2.00% in less than two weeks time.

Another Deutsche executive at the briefing opined that the capital markets can handle a rise in rates - if it is done in an orderly fashion.

Joyce told the briefing that "the selloff in both credit and EM has been significant. That is largely because those sectors that have benefitted the most from the QE will be the ones that feel it the most as we begin the tapering process."

He predicted that following the conclusion of the meeting of the central bank's policy-setting Federal Open Market Committee on Wednesday afternoon, Bernanke will likely "indicate to the market plans to taper reasonably soon," which Deutsche believes indicates a September start to the process, once the Fed has analyzed the unemployment figures and other economic data for June, July and August in order to come to the conclusion that the program can be safely wound down. He said that Fed will likely reduce the monthly bond-buying total at that time by $25 billion, to $60 billion a month, and will announce further monthly reductions of $30 billion in October and again in December.

At the same time, he said, there will be "a tremendous amount of emphasis to the market on something we should know already, which is that slowing down the rate of purchases is not tightening per se." Joyce also said that the Fed will emphasize the fact that "the actual raising of rates is still a 2015 event and still very data-driven. It will be made very clear that tapering decisions will also be data-driven."

Issuers turn cautious

In the meantime, junk issuance remains stymied, at least temporarily.

Besides the steep drop in new-deal volume, recent sessions have seen several deals that were actually in the market either postponed or pulled altogether.

On June 10, Warren Resources, Inc., a New York-based oil and natural gas exploration and production company, announced that it was postponing its planned $200 million offering of eight-year notes, citing current market conditions.

Just three days later, on June 13, Yankee Candle Co., a South Deerfield, Mass.-based designer, manufacturer, wholesaler and retailer of scented candles, announced that it was terminating its planned $450 million offering of five-year notes as well as snuffing out plans for a new $1.125 billion senior secured credit facility, which was to have consisted of a $175 million five-year amended asset-based revolving credit line and a $950 million seven-year first-lien term loan. The company further said that it was rescinding its previously announced notices of redemption for its $188 million of outstanding 9¾% senior subordinated notes due 2017 and its $315 million of outstanding 10¼%/11% senior toggle notes due 2016; those redemptions were to have been funded using some of the proceeds from the planned bond issue and term loan facility.

Also on June 13, Unilabs, a Geneva, Switzerland -based medical diagnostics and laboratory services provider, postponed its €685 million three-part offering of notes due to market conditions.

Sherlock noted that the pulled or delayed deals had already been in the market when rates were backing up.

Issuers thus decided against going through with the transactions at this time after deciding that the deals could not get done at acceptable prices.

Sherlock opined that now, "issuers are being a lot more cautious. The deals that are out there right now are the deals that need the funds in the short term," meaning the borrowers really have no recourse but to come to market even if conditions are not as favorable as they had been earlier for doing a deal.

"If you don't need to be in the market this week on the high yield side, you don't go."

Until things settle down a little, he projected that "most of the deals that get launched in the next few weeks are those that have to be in the market."

On the other hand, he suggested that "corporations just doing opportunistic refinancing deals are holding off," at least for now.

'Maturity wall' pushed back

Speaking of refinancing, Sherlock and the other Deutsche officials also noted the impact on issuance in the junk bond and leveraged loan markets of the dreaded "maturity wall" - looming amounts, in the many tens or even hundreds of billions of dollars of bonds and loans that are scheduled to come due within the next several years.

Despite the record or near-record issuance volumes successively seen over the past few years in the junk bond and loan markets, much of which was used to refinance existing debt, Sherlock said that "there's been no real reduction in the cumulative amount of maturing debt - the maturities have simply been pushed out."

For instance, according to data compiled by Deutsche Bank, bond and institutional loan debt scheduled to come due in 2014 and 2015 totaled some $506 billion at the end of 2009. Fast-forward to the end of this year's first quarter on March 31 and that daunting number had been chopped down by nearly $450 billion in the intervening three years, with just $14 billion of still-un-refinanced outstanding loans and bonds due next year and $50 billion due in 2015 -- amounts which the various Deutsche executives asserted would not be a problem for the market.

"We've pulled so much issuance forward into May, and if you look at the previous 12 months of issuance, we've refinanced much of the low-hanging fruit of near-term maturity we'd see in the next couple of years," Sherlock said."

However, going forward a few years, $133 billion of bonds and loans will come due in 2017, $259 billion in 2018. $282 billion in 2019 and $251 billion in 2020 - amounts which are expected to act as catalysts and drivers for continued active high yield bond and leveraged loan issuance going forward.

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