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In mid-May, Capella Healthcare’s senior management team was having one-on-one meetings with high yield investors in New York to pitch them a new USD 500m senior unsecured bond. Then, German Chancellor Angela Merkel announced a ban on naked short-selling and within days Capella was caught up in the global shock waves.
“We were busy on the road show and had no idea [what was happening in Germany],” Capella’s CFO Denise Warren told Debtwire. “The meetings we had with investors and banks were phenomenal.” The road show shifted to Boston, but Warren started to sense more investor apprehension by 20 May during the West Coast portion of the road show in Los Angeles.
The subsequent volatility clipped the hospital operator’s planned deal and others like it, as fund managers pushed for higher spreads to compensate for the broader market risk. Syndication bankers advised clients to take a momentary breathe but moderate deal flow will likely resume this month, said multiple bankers, analysts and investors.
Brentwood, Tennessee-based Capella has company in its new-deal limbo as Regal Entertainment, Jones Apparel, Penske Automotive, Americold Realty Trust and Allegiant Travel all recently postponed bond sales. Some companies pressed by near-term refinancing needs have tested the market, but corporates with longer term maturities continue to hold back and watch aftermarket performance of recent deals for signs of improvement.
So far, the evidence hasn’t been encouraging. Twelve of the roughly 23 companies that issued USD 500m or more of high-yield bonds during the past six weeks were still trading below issue price as of 7 June.
Investors also pulled out USD 5.1bn from high-yield funds in May, according to EPFR Global, a research firm in Massachusetts that tracks fund flows. That’s larger than the USD 4.62bn of cash that exited high yield mutual funds in October 2008 following the Lehman’s collapse.
“The tone changed,” Warren said of her recent marketing effort. “There was really no bid and ask, no bonds trading and it was difficult to determine a price at which Cappella would enter the market,” Warren continued. Nevertheless, the CFO said she thinks it will be weeks not months until the market for new high yield issues stabilizes, in the absence of an exogenous event.
More value in the secondary?
The recent selloff has also created some interesting opportunities for investors. Sabur Moini, who manages USD 1.5bn of high yield bonds at Payden & Rygel’s, says he took the opportunity to add to positions in higher rated names like Cablevision (Ba3/BB) and Chesapeake Energy (Ba3/BB) when they traded down to attractive levels.
CableVision’s 7.875% notes due February 2018 traded off to the 99-100 range from 106 in early May, before trading back up to 102.5 last week. Chesapeake’s 9.5% notes due 2015 slumped to 105-106 in mid May from 109.5 during the first week of May, before trending back up to 109-110.
Thomas O’Reilly, high yield portfolio manager at Neuberger Berman who holds Ford and GMAC high-yield bonds in his portfolio, is also looking to bolster his weighting of higher rated companies with the potential to move back to investment grade. He says he tends to underweight cyclical sectors like chemicals and favors defensive sectors, such as healthcare.
“The volatility in the market enabled us to hunt for selective BB rated bonds that traded down as much or even more than single Bs,” said O’Reilly, who helps manage USD 7bn of high yield bonds at Neuberger Berman.
Bond investors are overly concerned about near term default risk, according to O’Reilly, who forecasts default rates for the year will be much lower than the 7% estimated by the market. “We will see slower growth in the US but high yield bonds tend to do ok in a slow growth environment,” he said.
Buyers to drive harder bargains
Outflows from HY funds last month peaked at USD 2.1bn for the week ended 12 May, according to EPFR’s data. That figure dropped to USD 1.1bn for the week ended 19 May and zig-zagged back up to USD 1.94bn the following week. For the week ended 2 June, outflows calmed to USD 815m. Declining outflows are among the first signs of greater stabilization for the high yield market, but so far the record is choppy.
“June could be a very busy month,” said Richard R.S. Smith, head of high yield capital markets, Americas at RBS. “Buyside investors are looking for pricing that is attractive and they can’t avoid participation. We are close to that point. The market is oversold.” Smith said he thinks fundamentals in the US are strong enough to offset concerns from debt-laden European economies and re-animate the market he sells into.
New issuance will likely improve by mid-June, in part because the wave of refinancings in the past year took much of the near term risk out of the market, said Neuberger Berman’s O’Reilly. But he cautioned against expectations of a return to the volume pumped out in 1Q10 when more than USD 64bn of new paper was placed, an all-time record for the US high yield market.
For the near term, any new primary deals will be driven by buyers and their demands, including pricing, structure and covenants, said Marty Teevan, global head of credit markets at Cantor Fitzgerald, noting there is a significant backlog in the shadow calendar that is waiting for the right time to come to the market. “New issuances have to start clearing where the buyers care,” Teevan said.
“Two months ago people were buying without even looking at the prospectus,” says Riaz Haidri, co-head of trading at Gleacher & Company. “Now it’s a much different game.”
While high yield deals are still getting done, risk premiums have spiked, said the sources. “In the last 10 days, new issuers increased yields on average by 75bps to 100bps,” said Smith.
Capella Healthcare, for example, aimed to pay a yield in the low 9% range but buysiders pushed for a roughly 10.5% yield in order to refinance the company’s term loans due 2015 and 2016. However, the company doesn’t plan to sweeten the terms of the deal given its flexible timeline and initial positive investor feedback, according to the CFO.
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