NYSSA: RBC sees constructive environment for new-issue rebound to continue

By Paul Deckelman

New York, June 24 – High-yield new issuance is down from the pace it set last year and well down from the torrid pace that the primary side established over the last few years before that – but conditions in the market have improved over the last few months, leading to a recent rebound in new deals, and are a catalyst for continued issuance going forward.

That was a key takeaway from RBC Capital Markets managing director John Rote’s presentation before the New York Society of Security Analysts’ 26th annual high-yield bond conference this week in New York.

Rote told the conference attendees that the junk bond market had seen “huge growth” in the new issue market over the last few years, particularly during its ongoing rebound from the financial crisis of 2008-2009, which completely decimated new-deal activity in 2008. Activity came back up to around pre-crisis levels in 2009, but it wasn’t until 2010 that global issuance shot above the $300 billion mark. After a retrenchment in 2011, it was back above the magic barrier over the next four years, peaking at $398 billion in 2013, with 2014 not too far behind at $390.6 billion.

After that, though, Rote said that “what we’ve seen is a slowdown over [the] last 18 months or so, although that has certainly picked back up of late.”

Global issuance tumbled to $316.7 billion last year, and this year is even slower, with RBC estimating year-to-date new issuance at $147.1 billion, versus $214.5 million at this time on the calendar in 2015.

“We’re about 30% behind last year’s pace to date,” he said, though he noted “that’s an improvement. We were about 50% behind last year’s pace at the end of the first quarter.”

Energy, volatility key factors

Factors behind the slowing new-deal pace – both from 2014 to the present and between last year and this year – include commodity price pressures, notably in the energy sphere. Rote noted that energy issues alone made up about 15% of the high-yield market and pointed out that issuance in that sector fell from $66 billion in 2014, when oil prices began their long slide from $100 per barrel to current levels around half of that, to $37 billion in 2015 and to just $9 billion year to date.

There likewise was a decline in leveraged buyout-related new-deal activity from $21 billion in 2013 to $15 billion in 2014 and $11 billion last year, although he noted that issuance in this sphere is “starting to come back,” having crept up to $9 billion with the year only about half gone.

Playing a big role – as always – is market volatility.

Rote noted a change in the pattern of worried, event-driven market activity, measured by spiking junk bond yields and falling prices, from the way things were before the 2008-2009 financial meltdown.

“With new issuance pre-crisis, there used to be one or two months out of every 12 months that the windows were shut. [Since then], that has really picked up in terms of the windows being open and shut.”

For instance, he said, when in 2013 the market had its “taper tantrum” over the possibility that the Federal Reserve might eventually end its accommodative monetary policy and begin thinking about raising interest rates, volatility was largely confined to the second quarter and did not ultimately impact that year’s record issuance volume very much.

In 2014, the volatility from declining energy prices was spread over the third and fourth quarters and did bring new issuance down from the high-flying levels it saw in the year’s second quarter.

Things were even worse in 2015 heading into this year, between continually eroding commodity prices, fears of an economic slowdown in China and concerns about global growth generally. Volatility completely threw cold water on new issuance in the 2015 third and fourth quarters and this year’s first quarter.

Rote said that kind of multi-quarter volatility “is something we expect to continue over the near term and the intermediate term, as we’ve seen it over the last three years.”

However, the upside to such a pattern is that “when the [borrowing] windows open, a lot of issuers jump back in,” he said, as seems to have been the case during the present quarter, with global issuance more than doubling to $104 billion from the first period’s feeble $43 billion.

He elaborated that “when those windows open up and you now have a lot of issuers that have $10 [billion], $20 billion debt stacks, they need to have access to the high-yield market so they can take advantage of it when those opportunities present themselves.”

Using average junk bond yield-to-worst levels as a volatility indicator shows a considerable tightening of several hundred basis points, depending upon the index one uses, from their peak levels above 10% reached in early February – their highest yield-to-worst levels since 2009 – as energy prices have rebounded from their lows below $30 per barrel, the Fed has sent generally soothing signals to the market and soft economic data has ensured that a near-term rate hike is less likely.

Fundamental factors favorable

Against this backdrop, Rote pointed out favorable fundamental factors. “All things considered, it’s a relatively good time to access the market.”

He noted that U.S. Treasuries – the movements of whose yields represent another measure of fixed-income market confidence or worry – have been “a very cooperative environment,” which he says “has been responsible for a lot of the issuance” lately.

He also noted that flows of cash in to and out of high-yield mutual funds – which showed a $9.1 billion loss last year, the first actual year-over-year decline since back in 2007 – “have bounced back this year,” a rebound that has included “some of the largest inflows ever recorded.” Heading into Thursday’s weekly fund-flow reports, they topped the $5 billion mark, after having been in the $9 billion-to-$10 billion range earlier this year.

“So there are some good fundamentals. Consequently we’ve seen issuance really spike over the last few months.”

While noting the “virtual standstill” new issuance has seen over the past week, with just one deal having priced, he noted the impact of the “Brexit” referendum vote in Britain – the outcome of which was not yet known at the time Rote spoke – on the financial markets as well as the fact that with junk currently producing robust year-to-date returns of around 9%, “we’re approaching the end of the second quarter, and a lot of people don’t want to do anything to hurt their returns going into the quarter-end.”

The road ahead

Looking ahead, Rote declined to give any hard-number predictions as to where issuance would end up this year.

He said that some of the sectors that produced large acquisition-financing megadeals responsible for big chunks of last year’s new-deal total, such as pharmaceuticals and telecommunications, are not expected to be returning to the market with similar-sized transactions this time around.

And RBC expects energy-related issuance “to be down as well” as oil prices try to regain their footing, although he said that they are “actually starting to see” some drilling names coming back to the market.

“If that trend continues, it may pick up again.” But he cautioned that “it’s not getting back to where we saw ’13 and ’14 any time soon.”

Rote noted that merger-and-acquisition activity was at record levels in 2015, but 2016 “is off to a slower start, although it is still outperforming four out of the last eight years.” Ergo, he continued, “we think the high-yield market will be a significant source of capital for a lot of that M&A activity as well.”

Looking at the schedule of pending bond maturities that will have to be refinanced, Rote said that “we’re in a little bit of a lull over the next 18 months. It really starts to pick up in ’18 and ’19,” when $88 billion and $134 billion, respectively, will come due, plus another $178 billion in 2020, versus just $42 billion next year.

Given the prospects that interest rates could increase should the economy strengthen, he said that some chief financial officers and corporate treasurers may decide to “step in and refinance sooner rather than later, but we don’t see that as being an immediate catalyst in terms of spiking new issuance.”

The U.S. elections could be a source of some uncertainty, he said, “and the market does not like uncertainty.” He cautiously recommended a wait-and-see approach.

“All things considered, it’s a relatively good time to access the market.” – RBC Capital Markets managing director John Rote

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