Big and volatile

There’s a reason investors wait on the Federal Reserve’s decisions with baited breath.

In September, US companies issued a record $47.65 billion in new bonds, well above a previous record $46.8 billion raised in September 2012, according to a Fortune report that cites S&P Capital IQ/LCD data. As has been the case for most of the year, most of that high yield issuance was used as a refinancing tool – approximately 33.6 percent according to Debtwire statistics made available to Private Debt Investor.

September is always a strong month for new issuance in high yield, with many deals reaching completion only after investment professionals return from summer holiday, says Debtwire’s Kate Laughlin. Last month was no exception, though it may have also benefitted from the Federal Reserve’s decision to postpone the tapering of its quantitative easing programme, which allows for the monthly purchase of up to $85 billion in Treasuries and mortgage-backed securities. Quantitative easing places downward pressure on interest rates, which in turn reduces the cost associated with issuing new bonds.

With that in mind, it’s no surprise that borrowers took advantage of the continuation of low interest rates to refinance existing debt. Recent examples include Caesars’ Entertainment’s $4.85 billion refinancing, announced in September, as well as Kohlberg Kravis Roberts portfolio company First Data’s October announcement of its plan to repay a portion of its $2 billion in 11.5 percent senior payable-in-kind notes due 2016. The remaining notes will be exchanged for 14.5 percent senior PIK notes due 2019, the company announced in a statement.

The US high yield market has made a habit of responding to the Fed’s pronouncements throughout the year, which has resulted in rather lumpy month-on-month totals for new issuance, seen in the chart below.

The most noticeable dip in new issuance this year came during the second quarter, when concerns as to whether the Federal Reserve would continue to hold interest rates at zero began to spread through market. The result was a severe pullback in new bonds, with some companies – such as Yankee Candle, then-backed by Madison Dearborn – terminating proposed note offerings.

“Without the clarity of having low rates from near term or long term, there was a slowdown in issuance,” says Laughlin.

Whatever comfort companies or sponsors may take in the easy access to high yield, the push for new issuance has created risks for investors. In October, Moody’s Investor Service released data indicating that bond covenant quality had hit record lows in North America, with investors ready and willing to accept reduced terms in their ongoing chase for yield.

“US high yield bond issuance of $49.2 billion in September topped the previous record of $46.6 billion, set in May,” said Moody’s Head of Covenant Research, Alexander Dill, in a statement. “After the Fed’s decision to postpone tapering last month, companies may be seeking a last chance to restructure their balance sheets.”

A Moody’s spokesperson could not be reached for comment at press time.

With demand for yield so high, investors have apparently had no issue accepting reduced covenants. The Fed’s decision to delay tapering led to a dramatic inflow of capital into high yield funds, says Houlihan Lokey director Chuck Yamarone. Leveraged loans yields have floating rates, which protects investors in rising interest environments. High yield bonds tend to have fixed rates.

“I definitely keep an eye on the fund flows. When people thought the taper was coming in September, there was clear preference for floating rate funds versus fixed rate funds,” Yamarone tells Private Debt Investor. “The result was money flowing out of high yield funds.  Now we have seen five straight weeks of inflows.”


The availability of low-cost bond financing in the US has also led some European companies to seek access to credit on the other side of the Atlantic, Laughlin says. Even within Europe, however, low interest rates have led a growing number of companies to seek access to capital via the high yield bond market.

In Septemeber, for example, French smartcard manufacturer Oberthur Technologies tapped the US high yield market in a cross-border deal to help refinance some of the €770 of leveraged loans used to back its 2011 buyout by Advent International.

After issuance topped out at just $431 million August, European companies hit the market to the tune of $10.4 billion in September, according to Debtwire data provided to Private Debt Investor. As has been the case in the US, European high yield market issuance has been dominated by refinancing. Those bonds represented a 41 percent plurality of September issuance.

Interestingly, the lower and middle markets are beginning to assume a larger percentage of Europe’s bond market. Companies with less than $100 million EBITDA accounted for as much of 18 percent of the year’s issuance through October, according to Moody’s.

“It is encouraging to see the success of these relatively small companies in issuing bonds at the bottom of the ratings spectrum,” said Moody’s leveraged finance managing director Chetan Modi in a statement. “However, it remains to be seen whether this is a temporary consequence of investors’ search for yield, that will diminish as interest rates rise.”

At the moment, high yield remains an attractive alternative to other alternative financing solutions, including private debt funds. But given the markets’ volatility, it’s safe to predict that its popularity will wane as interest rates rise.