A slew of loan repricings, along with so-called covenant-lite deals, payment-in-kind toggles and dividend deals — the ingredients for a bubble are everywhere in the high-yield bond and leveraged loan markets. But investors, though bemoaning the tilt in the power balance back toward issuers, say they do not see a bubble forming … yet.
"Things are getting frothy. I don't want to use the bubble word yet, but there's some helium floating around," said Arthur Calavritinos, a portfolio manager at John Hancock Asset Management.
Others tend to agree. "Investors are chasing yields, but I would not characterize the high-yield or bank loan markets as being in bubble territory," said Matt Eagan, a portfolio manager at Loomis Sayles. "I think investors are responding rationally to the (Federal Reserve's) stance on monetary policy and to strong credit fundamentals. I don't see gross over-valuation in the space, though underwriting standards are clearly becoming looser."
The junk bond primary market just had its busiest January on record, according to Standard & Poor's. Volume reached $27.7 billion last month, which analysts said was not surprising given the demand for new issues in the last half of 2010. Companies priced $21.4 billion in new junk bonds in December. And roughly $34.2 billion in leveraged loans were launched on the primary market last month, according to S&P. Total 2010 U.S. leveraged loan volume was $233.44 billion.
The most recent deals getting done — repricings on the loan market being the most abundant example — are indicative of a market in which issuers are calling the shots due to pumped up demand. Dunkin' Brands, Burger King and Phillips Van Heusen are a few that made big repricings.
"Be careful of buying any loans above par, because of the rapid pace of repricing," said Tom Price, a senior portfolio manager in Wells Fargo's capital management division.
Issuers are even repricing loans with "cov-lite" terms. Gymboree, a San Francisco children's clothing retailer, is refinancing an $820 million term loan with an equal-size loan that drops the original's maintenance and capital-spending covenants and tightens pricing.
The junk bond market is also seeing deals with terms weighted heavily in favor of issuers. The Aleris International aluminum company priced $500 million in 7.625% senior notes due 2018 in a deal that the independent research firm Covenant Review called on investors to resist. A Covenant Review report said the restricted payment covenant is "seriously deficient" and the 103% call protection is "off-market for unsecured deals." But the deal nevertheless priced at par.
Meanwhile, PIK toggle deals are also starting to make a comeback. Florida East Coast Railways and American Commercial Lines both priced PIK note deals in order to pay dividends to private-equity owners this month.
The hot leveraged loan and high-yield primary markets are being fueled by increased investment from retail funds. John Hancock's Calavritinos said that the leveraged loan market's newcomers include even strategic income funds and global bond funds that are not dedicated to junk bonds and leveraged loans. "Nondedicated high-yield will be the first to bail out," he said. "It might be a year or two, but it will happen."
Flows into leveraged loan funds totaled $897 million for the week ended Feb. 2, according to Lipper FMI. "These are flow-driven sectors. If cash stops flowing in or reverses, bids will drop. However, the corporate credit market is underpinned by good fundamentals, so I don't expect anything close to a free fall like 2008," said Eagan, the Loomis Sayles portfolio manager.
