Amid turmoil, US high-yield market soldiers on

Fri Feb 7, 2014 2:29pm EST

NEW YORK, Feb 7 (IFR) - Equities may have taken a battering from the emerging markets sell-off, but the US high-yield market is taking it in stride, with risky paper being scooped up with little investor pushback.

Indeed, with a range of deals at the lower end of the credit scale printing in the past fortnight, some bankers are nearly at a loss to explain why the market has held up so well.

Yet buyside and sellside both agree that investors have not gone crazy and have remained selective - and disciplined - even as Triple C rated deals are comprising much of the action.

"Investors' appetite for income remains robust, and with an expected benign default environment, high-yield has continued to perform well," Gershon Distenfeld, director of high-yield debt at Alliance Bernstein, told IFR.

Against a 3% slide in stocks in January, high-yield returned 0.78%.

And while few expect this performance to continue if stocks don't stabilize, signs of a slow but steady improvement in the US economy nevertheless bode well for US high-yield.

Funds are sitting on cash balances of three to four percent on average, allowing leveraged finance bankers to make a go of even deeply subordinated deals like PIK toggles.

Ancestry.com tapped an outstanding PIK toggle for USD100m last week, while a subsidiary of Koch Industries used the proceeds from its toggle note this week to repay the USD240m it invested to finance the management buyout of American Greetings last year.

Volume in risky PIK structures could even be on the upswing, especially if equity market volatility makes it trickier for private equity to get out via an IPO.

"We're always pitching for PIK toggles," said one senior leveraged finance banker. "They are a good hedge against the equity market."

DEFAULTS WAY OFF

The easing of rates has also buoyed market confidence, with the 10-year Treasury yield now down to around 2.67% from 3% in early January.

"Rates have rallied, and there is not a lot of supply expected to come to market. That is making people buy paper while they can," said a high-yield banker.

"Stocks might be down, but they had such a great year last year, that I don't think this correction has really scared anyone."

In addition, the high-yield asset class is in general not really exposed to emerging markets, the banker said.

Taking that into account, it's perhaps more understandable that Triple C issuance - often a sign of trouble - accounted for two-thirds of supply last week by number of deals.

"Triple C issuance tends to be a determinant of defaults, and you could argue that they set the stage for the next cycle," said one investor.

"But we still think that 2014 will be a good year, and that we will be able to clip decent coupons."

US default rates currently stand at 2.2% and are expected to rise only to 2.3% by year-end, according to Moody's.

The investor added that the only obvious default candidates in the near term are retailers.

"When you look at the maturity profile of the leveraged finance market, there's nothing really material until 2017-2018. There's not much new leveraged buyout activity either, which is usually what causes a default problem."

EYE ON THE CYCLE

Issuers are getting good pricing, too. Drug maker Patheon priced one of the lowest-yielding Triple C leveraged buyout bonds even as the EM meltdown was rippling through markets.

And even the appearance of two rare unrated deals - North Atlantic Drilling and Intrepid Aviation, which together amassed more than USD2bn of orders - is being seen as inconsequential. Only seven such trades have priced since 2010, according to IFR data.

Heading into the latter stages of next year, however, investors will likely need to tread more carefully.

"Overall, companies are well positioned, but investors need to be cautious as we get later in the credit cycle," said Distenfeld.

"If you think about where defaults have historically come from, it's most often when a company re-levers its balance sheet just as their underlying business starts to weaken."

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