Chasing yield

During the second quarter of 2011, high-yield bond issuance in the US reached $72.9 billion, a 91 percent increase on the same period in 2010, according to Fitch Ratings. The surge capped off the busiest first six months on record for high-yield issuance in the US: the first-half total of $146.4 billion was 43 percent up on last year’s equivalent figure. It was a similar story in Europe, where corporate high-yield issuance hit €36.8 billion during the first half, Fitch said, surpassing the previous record of €34 billion in 2010.

In other words, the high-yield market was once again becoming the go-to source for both acquisition capital and debt refinancing. “The high-yield market has been extremely active given the low rate environment [and] the ability to lock in long-term rates at pretty attractive levels relative to historical yields,” says Adam Sell, a director at advisory firm Loughlin Meghji & Company.

According to data from ratings agency Standard & Poor’s, the bulk of private equity refinancing needs to happen during 2013 and 2014 – but GPs know it would be rash to put off taking action until then. With reduced bank lending ability and a lower appetite for risk, high-yield bonds ought to be a crucial source of liquidity for European refinancing, according to Fitch. 

But there’s a catch. In June, high-yield issuance in both the US and European markets experienced a dramatic decline, returning to levels not seen since 2010 – and staying there through to mid-August.

“The world just fell apart at the end of July between the European crisis continuing to accelerate and our government’s [debt negotiations],” says Sell. “Any time there is that sort of exogenous factor thrown in, people generally look at their risk profile and skew more conservatively.”

The European debt crisis has introduced additional uncertainty into an already fragile economy, while the recent US credit downgrade took its toll on US equity markets.

“Just as you’re seeing volatility in the equity markets, you’re going to see volatility in these leverage markets,” says managing director at CCMP Capital Kevin O’Brien. “I think in general what we’ve seen over the last year is very much of a windows market – periods of opportunity offset by periods of volatility and disruption.” A similar thing happened after the devastating tsunami in Japan, he points out.

“I think the greatest difficulty in the current climate is the complexity in pricing when there’s tremendous volatility in the market, therefore shutting down the high yield market and probably most finance markets for a limited period of time,” says partner at law firm Ropes and Gray Jonathan Bloom.

However, although periods of volatility will have a negative impact on the volume of issuance, it can work to a buyer’s advantage. “It was actually an opportunity for the buy side to push back on pricing, and they did so aggressively,” O’Brien says.

Investors also received some good news on US interest rates from the Federal Reserve in August. “You have [Ben] Bernanke saying, ‘Don’t worry, rates are going to stay low until mid-2013.’ That to me bodes very well for a user of that financing,” O’Brien says.

While both the US and Europe have witnessed record high-yield issuance, the surge in volume is perhaps more significant for acquisition finance in Europe.

“In the US, high yield has always been a part of the acquisition finance market. It’s a product that’s been used, tested, supported and has always played a role in the capital structure in acquisition finance,” Bloom says. “In Europe, it’s only recently that high yield has been seen as a relatively important piece of the capital structure in acquisition finance.”

On 2 August, Ropes & Gray arranged €250 million of high-yield financing for London-based mid-market firm Vision Capital when it bought a portfolio of assets from Banco Popular, the largest of which was Italian glass-maker Bormilio Rocco. “I think it’s significant in showing that European private equity shops can use high-yield as a component in acquisition finance,” says Bloom.

Glass-half-full types might argue that the drop in high-yield issuance in July was just a case of the traditional summer lull arriving early. “In my experience, the last two weeks of August are typically quiet for new issues. But given the market volatility this year, I think the markets just closed a little bit sooner,” says Bloom.

But will the market bounce back to first-half levels? It looks unlikely. “We’re in the August shut down window at this point, and so the $64,000 question coming post-Labor Day, at least in the [US] – and I think in Europe – is ‘What’s the outlook for financing deals for the last third of 2011?’” O’Brien says. “I think you’ll still have a windows market.” For now, the window appears to be shut.