Deutsche sees high-yield, leveraged loans on track to approach last-year’s totals, more M&A

By Paul Deckelman

New York, June 20 – Last year saw record new issuance and strong trading levels in the leveraged loan and high-yield bond markets – and despite expectations in some quarters that issuance would fall off this year and the markets would retreat amid fears of rising interest rates, both are on track to at least match, or perhaps even surpass, last year’s activity level while maintaining strong performance, according to the market-watchers at Deutsche Bank.

“A lot of pundits thought that rates would be moving up much quicker,” Deutsche’s global head of equity capital markets, Mark Hantho, said at the company’s annual mid-year corporate press briefing this week in New York.

“That has not happened. In fact, there’s been a resurgence of issuance on the debt side,” he said, although he predicted that a recent relative pause in flows of investor capital coming into to equity funds in favor of money going to fixed income would likely subside in the year’s second half.

Deutsche’s managing director for leveraged debt capital markets, Sandeep Desai, meantime told reporters at the briefing that “we are in the third year or the fourth year of a very robust cycle from a fixed-income issuance perspective” with yields on both leveraged loans and on junk bonds at all-time tight levels and spreads for those two asset classes versus comparable Treasuries not too far away from their tightest levels.

Desai said coming off last year’s big issuance and with continued strong activity so far this year, outstanding volumes in both the leveraged loan and the high-yield markets are up over 30% from where they stood at the end of 2012.

As of April 30, the leveraged loan market saw some $725 billion of leveraged loans outstanding, almost all of it institutional first-lien bank debt, while outstanding volume in junk topped the $1.5 trillion mark, the vast majority of that in senior unsecured notes, though with a sizable chunk of senior secured paper also in the mix, “so the markets are obviously in great shape.”

On a year-to-date basis, Desai said that leveraged loan institutional issuance was “on track” to match last year’s approximately $450 billion of such debt, “so we’re halfway there,” while on the junk bond side, issuance patterns “are almost the same.” Junk issuance of some $174 billion is actually running slightly ahead of the $167 billion that had come to market by this point on the calendar in 2013, with full-year issuance expected to be “plus or minus in the Zip code” of last year’s well over $300 billion of new high-yield securities.

Less re-fi, more M&A

Even as strong issuance levels are at or above last year’s, Desai said one major difference between 2013 and 2014 has been a shift in the use of proceeds.

In both leveraged loans and bonds, refinancing activity has dominated new issuance over the past few years, helped by the continued low-interest rate environment.

The chance to borrow money at historically low interest rates caused corporate treasurers to make a beeline for the leveraged loan and junk markets, cleaning up all of their near-term debt and extending maturities, in some cases as far out as 10 years or even more. They were also taking the opportunity to get rid of their most expensive, highest-coupon obligations, even if these weren’t necessarily scheduled to come due anytime soon.

While refinancing activity in both loans and junk accounted for over 60% of the new issuance last year, so far this year, that has dwindled to just 34% in both markets.

While that’s still the largest single use of proceeds, merger and acquisition activity has accounted for 23% of all junk market activity and growing, with leveraged buyouts accounting for another 19%, followed by recapitalization and dividend deals at 12%, and 12% for other uses, for instance, capital expenditures. The breakdown in the use of leveraged loan proceeds is similar to that in junk.

“The last few years were great years from a re-fi perspective,” Desai declared, though adding “I think the next few years are going to be M&A-oriented.”

He said that here and there, “there might be a few [loan] transactions done in 2010 and 2011 being taken out, as in the bond market, but that is really going to be a smaller chunk of issuance” versus what it has been.

While “the driver this year has been a lot more M&A, unlike years past,” when refinancing was the main focus, he noted that at least so far this year in the loan market, “you haven’t seen the same-sized transactions as you saw last year,” such as the huge buyout deals for Dell Inc. and H.J. Heinz Co.

Performance remains robust

Desai said that loan market spreads are “still pretty close to all-time tights, although in the last couple of months they have widened out by 25 to 50 basis points,” as investors reacted to potentially unfavorable comments earlier this year from the Federal Reserve.

But even as some technicals have recently weakened on the loan market side, Desai said that the market was being helped by a revival in collateralized loan obligation issuance, particularly in March, April and May. He predicted that “we may have – in my mind – a record year” for CLOs to rival the last big years for that asset class in 2006 and 2007, which saw $80 to $90 billion of new CLOs in 2006 and then $90 to $100 billion in 2007.

Desai said that flows of cash into high-yield funds, now at an estimated $6 billion year to date, have been “really solid,” with some of that cash coming from investors who might have otherwise put it into loan funds.

Since about mid-April, money flows for the loan funds have turned negative, after previously racking up a spectacular winning streak of nearly two consecutive years of weekly inflows. The loan funds saw about $360 million of net outflows in the latest week, ended Wednesday, and outflows of about $1 billion per week in the two weeks before that, while loan yields and spreads have backed up versus their earlier strong levels.

However, the Deutsche Bank executive said, “these are all marginal. From an all-time perspective, both the markets are in good shape.”

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