Credit Suisse notes recent volatility, says more deals could be pulled

By Paul Deckelman

New York, May 24 - After a sterling first quarter and at least an OK April, the junk bond market has recently turned volatile, leading to the postponement or cancellation of several recent high-yield deals - and the experts at Credit Suisse believe that there could be more of those coming.

"Clearly there's a lot of volatility in the marketplace in both loans and bonds," David Miller, the big investment bank's global head of leveraged finance capital markets, said at a briefing for the financial media on Thursday.

More issuers may delay

When asked if the junk market might see more such failures as this week's Generac Power Systems Inc. debacle, he acknowledged that "we could see more of that. In the last week and a half, about six high-yield bonds were pulled due to market conditions."

Generac, a Waukesha, Ill.-based maker of power generating equipment, had been shopping a financing package around the capital markets consisting of a $425 million issue of senior notes due 2020 and an $800 million term loan and was going to use the proceeds from those borrowings to pay its shareholders a special cash dividend of up to $10 per share and to repay existing credit facility debt.

However, on Monday, the company announced that it would not be doing that bond deal, citing market conditions, although it would go ahead with the term loan. The total financing package was downsized to $900 million from the original $1.2 billion.

Generac is only one of several prospective issuers to recently decide to either cancel or at least delay their planned deals. On Wednesday, Univar, Inc., a Redmond, Wash.,-based distributor of industrial and specialty chemicals, was heard by high-yield syndicate sources to have postponed a planned $750 million offering of seven-year senior notes.

Another recent no-show was Harland Clarke Holding Corp., a San Antonio-based provider of integrated payment, marketing and security services and retail products, which last week postponed a $295 million offering of seven-year senior secured notes. Germany's Monier Group, a supplier of roofing products and services, put off its €250 million issue of seven-year senior secured notes.

Miller said that potential bond issuers all have in mind what he termed a "reservation price," the point at which the issuer believes that it is not worth doing that deal.

He contended that "each one of those deals [that was pulled] could have gotten done - but at a price. The issuers had a 'reservation price' in their mind."

This is particularly true in the case of opportunistically timed deals, rather than event-driven transactions where there may be some kind of a deadline that makes such a deal necessary such as the need to fund a tender offer or to finance a leveraged buyout or other merger and acquisition activity. For instance, like the canceled Generac deal, Univar's proceeds were to be used at least in part to fund a distribution to shareholders.

Without addressing the specifics of any of the withdrawn or delayed deals, Miller said that opportunistic issuers who decided not to do a deal "didn't have to do anything, and they'll wait for the market to come back" to pricing levels they're willing to pay.

Credit Suisse is one of the leading junk bond underwriters, and Miller said, "We know what the market conditions are now, and we're advising people where they can get deals done now. But if there is continued deterioration for whatever reason, we'll see more deals pulled. If we have stability, we won't."

Fast start after a slow ending

Miller's colleague, Jeff Cohen, the co-head of U.S. syndicated loan capital markets, pointed out during the briefing that the roughly $270 billion of new junk issuance seen in 2011 "was a big year," although it was down from 2010's record pace by about 13.8%.

The first quarter of this year "was a record quarter" at $99.9 billion of new issuance.

Junkbondland, he said, "rallied tremendously during 2012 coming off the third and fourth quarters of 2011," when issuance slowed markedly from the previously red-hot pace as yields climbed amid prolonged market volatility linked at least in part to the ongoing European debt crisis as well as deficit worries in the United States.

After the fast start early this year, "you can see how in May, we've seen the market back up a bit, and we're expecting to see yields go potentially even higher on the high-yield side."

Miller allowed that "even this $22 billion that was done in April and what we think will be in May, still in a historical context, is a very, very good pace coming off a record first quarter."

He said that it's "no surprise" that yields were lower earlier in the year than the second half of 2011, "especially when so much of the marketplace right now is opportunistically driven."

However, he cautioned that "the opportunistic deals are going to go away when the yields kick up, like we saw in the third and fourth quarter last year."

Miller said that even though market volatility has knocked new issuance off the record pace seen earlier in the year, there is no shortage of potential bond deals that could appear - if the conditions are right.

"We have quite a few that are teed up. That is, if the market gets back to where it was, they'll go."

Déjà vu all over again?

But for the moment, conditions are unsettled.

Miller said that right now, "it feels a little bit like last July. We had a bunch of people teed up to go [with new deals], the market was good, but they missed the window. It was August, then Labor Day, and they kicked themselves for not having gone in July."

Average junk bond yields were around the 7% mark in late July but then began climbing in August, about the time that U.S. congressional negotiators failed to make any meaningful progress in reining in the federal deficit and Standard & Poor's issued its unprecedented ratings downgrade, knocking U.S. Treasury debt off its long-held AAA perch for the first time that anyone could remember. Yields quickly shot past 8%, then 8.5% and even north of 9%.

Junk issuance, which had been a respectable $20 million in July, swooned to about $1 million for all of August and did not get much better after that - $7 million in September and $10 million in October. Some of the junk market's old swagger came back in November, when issuance hit $24 million, but then the primaryside went home for the holidays in December, when just $3 million of new junk came down the chimney.

Miller opined, "That, I believe is a lot of the reason why the first-quarter issuance in high yield was a record quarter. You had all of that pent-up demand [that didn't get done in the third or fourth quarters]. They had missed the earlier window, so in the first quarter, the market came back very strong," producing record issuance.

Cash is king

Cohen agreed that "what happened in the fall of last year was a dearth of high-yield bond activity." In the meantime, though, cash in the hands of investors continued to mount up.

Cohen noted that "the high-yield bond market is a trillion-dollar market. Even if there isn't a lot of new cash coming into the market, you have this pool of $1 trillion of bonds at an average rate of 8%, so you've got a massive amount [of] coupon payments coming in, almost $80 billion a year, that's going to cycle back into the market."

He said that when January came around, "portfolio managers looked around and said 'We don't see any imminent signs of world distress, and we've got a ton of cash here.' So they started buying and we saw a dramatic rally in bonds in the first two weeks in January."

At that point, he said, "all of those issuers who regretted not doing deals in May or June of last year rushed in, so January and February were huge months."

Little M&A activity, while dividend deals on hold

Miller said that in both the high-yield market and in leveraged loans, "up until about four weeks ago, there was a trend line of tightening spreads and more aggressive structures." Borrowers with greater leverage were hitting the capital markets, and dividend deals were getting done, although all of that no longer seems to be the case.

"It's a lot like last year, in that way," he said.

While here and there a few big M&A deals appeared, including Tulsa, Okla.-based oil and gas exploration and production concern Samson Investment Co.'s $2.25 billion eight-year deal in February and Houston-based energy operator El Paso Corp.'s $2.75 billion issue of seven- and eight-year paper in April, Miller and Cohen said that on the whole, relatively speaking, there's been what Miller called a "dearth" of merger activity, which normally would be a potent driver of bond issuance.

Cohen said that "in the absence of M&A activity, you've got refinancing old bonds, refinancing old loans or dividends. Those are the only reasons an issuer would be in the market."

But the demise of two prospective dividend deals in one week would seem to indicate that investors now have less of a tolerance for such transactions.

Cohen predicted that "we're going to see dividends if the market rallies. But if the market stays soft, you probably won't see a lot of bond activity until prices rise."

All in all, he concluded, "it will be very interesting how the year turns out."

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