High-yield bond issuance in 2016, which stands at $228 billion, is likely to fall about 13% short of the total for 2015, to mark a fourth consecutive annual decline. Most forecasts project at least a modest rise in the year ahead, but projections for issuance and high-yield returns cover unusually wide territory, as expected rate volatility dovetails with fiscal uncertainty attendant to the incoming Trump administration.
In the year ahead, the Street predicts an uptick in M&A transactions, which naturally could lend well to overall high-yield volume. One particular area of focus expected to be ripe with acquisition activity is the technology, media, and telecom (TMT) sector.
Corporate M&A issuance for 2016 was 12.9% of overall volume, according to LCD, down from 29.82% in 2015.
Meanwhile, LBO-focused bond deals accounted for 5.93% of volume for 2016, versus 3.29% in 2015.
“My guess is the first part of the year we will see a surge of activity as companies look to refinance their debt before rates go higher; our greatest concern would be if we saw a large uptick in volume to finance LBO transactions,” says Scott Roberts, head of high-yield for Invesco. “Generally when we see an uptick in LBOs, we see an uptick in defaults.”
At the tail end of 2016, the shadow calendar was already loading up, with expected issuance earmarked for LBO/M&A activity. The market expects Hartsville, S.C.–based packaging company Novolex to print $625 million of senior notes to back Carlyle’s buyout of the company from current majority stakeholder Wind Point Partners and minority owner TPG Growth.
Also, newly formed cable operator Radiate Holdco has set its sights on $495 million of notes due 2024 to help finance its acquisition of RCN Telecom Services and Grande Communications Networks.
By Morgan Stanley’s estimates, total issuance will reach $244 billion for 2017, which will be “modestly higher relative to likely 2016 volumes,” according to analysts in the investment bank’s outlook report. But, due to a further pushed-out maturity wall for most bond issues, we can expect to see a modest decline in issuance geared toward refinancing, at just $136 billion of the overall total, Morgan Stanley adds.
Similarly, Deutsche Bank expects $240 billion in total new issuance, noting that higher all-in yields, low refinancing needs, foreign cash repatriation, lower debt tax deductibility, and less cross-border M&A will affect the overall figure.
Predictions by analysts at Wells Fargo Securities also place total new prints in 2017 at $240 billion, which works out to a 10% increase year-over-year.
J.P. Morgan’s outlook is perhaps the most ambitious, at $300 billion in new issuance anticipated for high-yield bonds by the end of 2017, and $400 billion for institutional loan issuance. J.P. Morgan expects an increase in general corporate and M&A-related opportunities to offset a modest decline in refinancing activity, it said in a research report.
“Though not as active as a few years ago, capital market conditions for high-yield issuers are expected to remain robust,” analysts at J.P. Morgan note.
Ask BAML strategists, and volume for high-yield bonds will be far less than the majority of Street expectations, at $200 billion, or a 6.5% year-over-year decline, “due to fiscal uncertainty and the potential for a corporate tax cut which would increase the after-tax cost of debt.”
|While the primary cooled this year, the secondary ran hot. Returns in the secondary market were nearly 16.5% in 2016, through Dec. 16, according the Barclays U.S. Corporate High Yield index, following a 4.5% loss in 2015 and a narrow 2.5% gain in 2014. The OAS for the index is at 405 bps this month, from 660 bps at the end of 2015 and 483 bps at year-end 2014.
Predictions on returns for 2017 vary widely, from negative 2.7% to positive 10–12%. Energy sector woes will likely be less of a headline grabber in 2017, but the effects of policies from the new Republican presidential administration rank high on the list of concerns.
On the bullish end, J.P. Morgan analysts expect HY to return 10–12% in 2017. Wells Fargo Securities analysts say spread compression, combined with a 60 bps move in the five-year U.S. Treasury, should lead to a 5–6% total return, while Bank of America Merrill Lynch’s forecast is at 4–5% for high-yield bonds.
Among the bears, Deutsche Bank sees a –1.2% return next year, and Morgan Stanley –2.7%. These outlooks are based on the planned rate increases and predicted spread widening. For 2017, Deutsche Bank pins high-yield spreads at 550 bps, an increase of 55 bps from current levels, and Morgan Stanley expects a widening to 643 bps.
Marty Fridson, Chief Investment Officer of Lehmann Livian Fridson Advisors LLC, and contributing analyst to LCD, noted in a recent research report that “BNP Paribas foresees ‘pedestrian single-digit carry-type returns,’ which sounds like a coupon-clipping year, but is not based on an assumption that rates and spreads will be stationary. Instead, strategist Mark Howard expects underlying Treasury yields to rise but thinks credit-enhancing acquisitions by investment-grade companies will offset some of that damage.”
Fridson said that while a double-digit return is a not high-probability outcome for 2017, it is not impossible when taking into account interest rates, GDP, default rates, and valuation. Indeed, while the option-adjusted spread (OAS) of the BAML High Yield Index was tight to end the year, at just 428 bps on Dec. 9, that index in 2006 returned 11.77% and beat the BAML Treasury Index by 863 bps, even after the OAS began the year at an even tighter 371 bps. Fridson adds that in 2010 and 2012—years of 15% high-yield returns—the BAML High Yield Index began the year at spreads that indicated extreme or very nearly extreme overvaluation, according to the FridsonVision Fair Value Model.
Invesco’s Roberts experts the actual result to fall in the midrange of Street predictions. “Returns in 2016 are highly unlikely to be repeated in 2017. The returns outcome will not be as large in the years to come. Our thinking is the market is probably in that 5% range.”
Going into 2017 one thing seems certain: there will be additional rate hikes. The final two-day Federal Open Market Committee of 2016 revealed a boost to the target range for the federal funds rate to 0.50–0.75%, though the committee noted that the path of further hikes will remain gradual and dependent on the economic outlook.
The market will likely sustain itself against any rate increase, says Mary Bowers, senior portfolio manager, global high-yield at HSBC Global Asset Management.
“High-yield is pretty well-positioned for a rising rate environment,” Bowers notes. “We are late in the credit cycle, however, so spreads have compressed pretty significantly now that we’ve moved through the energy bubble and that constrains our return potential.”
Additionally, in an earlier Bloomberg survey, economists predicted the 10-year Treasury yield would finish 2016 at 2.32% and rise by 34 bps, to 2.66% at the end of 2017. Between the November election and the December FOMC announcement on rates, the 10-year Treasury rate had tested 2.6% for the first time in two years, already hitting those forward expectations.
In the days following Donald Trump’s presidential victory the market saw immediate indications of who the clear winners and losers were, on a sector basis. And while investors initially continued to pull cash from high-yield bond funds following the results, cash began pouring into the investment vehicles, thwarting fears of an exodus sparked by the planned rate increases and inflation under Trump’s administration. As of Dec. 14, the year-to-date total inflow to below-investment-grade bond funds is $10.55 billion, according to the weekly reporters to Lipper only. A year ago, the measure was an outflow of $5.89 billion.
In the energy space, bonds backed by coal companies rallied, as the president-elect had vowed to scale back on regulations in the sector. Trump has also been vocal about the lack of success of the Affordable Care Act (ACA) and vowed to repeal or revise the mandate once in office. In turn, healthcare names took a hit in the secondary market and the sector is projected to face further pressure in the year ahead.
“While we don’t expect any major issues for large high-yield sectors there will be a lot of headline risk/trading around healthcare,” says HSBC’s Bowers.
That can probably be said for a number of sectors, given the uncertain environment of a Trump presidency.
Analysts at S&P Global Ratings note that uncertainty around ACA intensifies risks for healthcare services providers. “We believe the healthcare services sector faces the greatest risk of downgrades when considering the trends now shaping the healthcare industry,” a Dec. 15 S&P Global Ratings report notes. “Healthcare reform has been a hot topic for well over two decades, but it is now well-entrenched, and we do not envision a return to the days of old. The tumultuous political environment may call into question the path further reform will take, but in any reasonable scenario, the credit risk is greatest for health care services companies.”
Additionally, ratings in the pharmaceutical sector are also expected to remain strained largely due to the potential for increased M&A activity in the sub-sector, where companies may compromise the strength of their balance sheets to boost product pipelines or improve their competitive positions, S&P Global Ratings says.
Upcoming fiscal policies could prove to be a fruitful for high-yield issuers, but potentially bad for their debt holders, which may fall further in the repayment queue, with companies prioritizing shareholders. Under Trump’s administration, we could see a 20% corporate tax rate, and the ability for companies to completely expense capital investments. Also being bounced around is the inability to deduct net interest payments.
“Though non-deductibility of interest is a headwind for issuance, the lowering of corporate tax rates would provide a counter effect,” notes Michael Contopoulos, high-yield credit strategist at BAML, in a report. “As such, we think that investment related issuance could increase if these two changes combined were to be approved. Additionally, we think the option to fully expense capex upfront could also create a large incentive to issue debt for capital investments.”
On the flip side, with the influx of cash resulting from these measures, companies may not place debt repayment high on their priority list, says Invesco’s Roberts.
“It’s possible that companies will be repatriating a large amount of cash that we have in foreign markets,” says Roberts. “Money could come back and go to stockholders, and we could see one-time dividend payments, but it is not clear how this will play out for debtholders. Debtholders would rather see a pay-down their way.”
This story first appeared on www.lcdcomps.com, an offering of S&P Global Market Intelligence. LCD’s subscription site offers complete news, analysis and data covering the global leveraged loan and high yield bond markets. You can learn more about LCD here.