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Leveraged Finance News: Appetite Is There for Large HY Deals

Date: 20-Jan-2012

Investors may not be saying, “Supersize me,” but the junk bond market does have an appetite for large deals. Buyers have money that they are eager to put to work in assets that offer some kind of yield, and defaults on speculative-grade debt, while rising, are expected to remain low by historical standards.

So while risk aversion will likely ebb and flow as the market reacts to macroeconomic forces, and while analysts agree that 2012 will likely see lower high yield volume than 2011, large bond offerings ($1.5 billion or more) may increase in frequency.

The standard sized high yield deal usually falls between $250 million and $750 million. The deal size average for 2012, so far, is approximately $630 million.

“I think you’ll see [large high yield deals] more than in the past,” said James Holtzman, an adviser at Legend Financial Advisors. “It’s much easier to get the funds for bond deals, especially with interest rates being so relatively low.”

To some extent, big junk bond deals are coming at the expense of the leveraged loan market. Case in point: one the largest leveraged buyouts of 2011. In late November, JPMorgan led a group of 10 banks in providing a $2.25 billion bridge-to-high yield bond facility to help finance KKR’s $7.2 billion purchase of energy producer Samson Investment Co. The company also secured a $2.25 billion asset-based revolver to help back the deal, but there was no institutional or pro rata loan piece.

This runs counter to the way large sponsor-driven deals, as well as most large speculative-grade deals of any kind, are typically financed. “The preference is to put as much as you can in the senior secured first-lien term loan,” said Richard Farley a partner with the corporate practice at law firm of Paul Hastings who focuses on the high yield market. “There’s always a desire to do that since there’s generally senior debt. When the demand for a first-lien piece is maxed out then you have to find a home for the rest of the capital structure; that’s bonds or mezzanine or in some cases in second-lien.” Investors generally like loans because they are less risky and can be paid off or refinanced early, but loans pay less when interest rates drop, and the expectation of low defaults (in the area of 2%) assuage some fears about high yield bond risk.

What’s different in today’s market is that the quest for yield is leading investors to take on additional risk in order to get additional return. “Investors are looking at a market where they won’t have rising rates in the next year and can get better value in the fixed-rate rather than the loan market,” said Joseph Stein, a partner and managing director in the restructuring and recapitalization group of Peter J. Solomon Co. “Loan markets can be hot when you’re in a rising rate environment and you feel like defaults may be high or creeping up,” Stein said.

Have Cash, Will Travel

He pointed to the increased money flowing into high yield bond funds as evidence of this trend: High yield bond funds took in $1.79 billion for the week ended Jan. 11, according to Lipper FMI. This is a big jump from the previous week’s $774 million in flows and the first time junk bond fund flows have topped the $1 billion mark since the first week of December. Lipper lists total assets for high yield bond funds including ETFs at $132 billion.

Ron D’Vari, CEO of New Oak Capital, thinks that junk bond deals stand to get bigger because there are few competing products that are attractive in the current environment. He said there is little CMBS and almost no non-agency mortgage products. “There’s also a lot of cash on the side with central bankers flushing the markets with liquidity,” he said.

Samson, should it price on the junk bond market this month as planned, would be the latest deal to hit or break the $1.5 billion mark. The most recent issuers to price at or above that measure include Fresenius Medical Care, which issued $1.82 billion in a three-part bond deal that included a euro-denominated tranche; MGM Resorts International, which issued $1.7 billion in a two-part deal on Jan. 11; Amerigas Finances, which priced $1.55 billion in a two-part deal on Jan. 5; and Peabody Energy, which issued $3.1 billion in junk bonds on Nov. 7, the same day that WPX Energy hit the market with a $1.5 billion deal.

In addition to Samson, other large high yield deals expected to come to market include a $2.2 billion bond offering of both secured and unsecured notes sold by United Rentals in the first quarter and a total $3.2 billion junk bond package to be issued by Energy Transfer Equity, according to Fitch Ratings. Neither company has a corresponding leveraged loan on the forward loan calendar, according to Fitch.

“Clearly the bankers who are making the decisions to commit think there’s an appetite for large bond deals,” said Farley. “I don’t think there’s a cap out there now in anyone’s mind in terms of dollar size. I think it’s the opposite now. The market is craving inventory, craving product.”

Back in the New Issue Groove

The junk bond market sprung back to life in January after a relatively dreary fourth quarter 2011. As of Jan. 17, a total of 16 issuers had priced $10.18 billion. This already more than doubles December’s new issue total of $3.9 billion via 11 deals.

Industry observers agree that the market is wide-open for deals right now and there is not much hesitation on the part of issuers. “Anything that’s out there now is full speed ahead. I see no reluctance to bring things to market. The issue now is that there’s not a lot of inventory out there,” said Farley, who thinks that new issue volume this year will be more driven by M&A activity and LBOs than in the more recent past. “We’re well positioned to have a robust LBO market and a robust high yield finance market. … The fundamentals look as good or better as they’ve been since we went into the recession.”

A relapse into recession is a constant fear on the high yield bond market that would snag new issues, larger issues especially. As with other financial markets, all eyes appear to be on Europe. Bits of bad news will stall the new issue market for short periods of time, and a full-blown European recession—some say Europe’s economy is already recessionary—could spread to the U.S. and disrupt financial markets, at least initially by raising rates. “You would see a slowdown in larger junk bond deals at that point,” said Holtzman. “Rates won’t jump up immediately but it would happen pretty quickly.”

And other market participants see the situation in Europe as something that may have some solutions on the way that may calm markets. “Overall I expect this year we are actually going to see less aversion to risk once we get additional clarity in the Eurozone situation, which I believe will be slow to come but in the works,” said D’Vari.

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