High-yield bonds are in; loans are out.
Barriers to the high-yield bond market have been crumbling and activity is intensifying, spurred largely by the recent cuts in interest rates and narrowing spreads. One side effect: Money going into high-yield bonds means money coming out of the leveraged loan market.
High-yield bond issuance bounced back in January, with 32 deals reaping proceeds of $14.2 billion, up from seven deals generating $1 billion a month earlier, according to Thomson Financial Securities Data. In January of last year the high-yield bond market generated only 18 deals, worth $5.2 billion, according to Securities Data.
The capital flowing into the high-yield market is not just hot money, said Joe Galzerano, an executive director at CIBC World Markets. It is coming from all over, from sources such as mutual funds and insurance companies.
So popular are high-yield bonds these days that some issuers have abandoned plans for bank financing.
American Tower Corp., a Boston telecommunications infrastructure provider, had planned to take out a $500 million loan but decided instead to increase its bond issue. It subsequently canceled the loan, said Chris Donnelly, a loan market research analyst at Portfolio Management Data.
Alamosa PCS, a Sprint PCS affiliate, made a similar move. The telecommunications company placed its high-yield offering at $250 million and scaled back its bank debt to $280 million from $305 million, Mr. Donnelly said.
Global Crossing Ltd. and Allied Waste Industries Corp. paid down their bank loans by using high-yield bond capital to buy back bank debt, Mr. Donnelly said.
The coupon rate, relative to what they can do in the bank market, is attractive, Mr. Galzerano said.
The reinvigorated bond market, now open after being closed for about 18 months, is taking pressure off the loan market, which has been the main source of financing for companies during that time. A hot bond market will ultimately benefit its close cousin, leveraged lending. When activity in the bond market picks up, so to does the loan market, with companies often taking both types of funding simultaneously. With both markets open, there is more flexibility and less need for one market to compensate for the other.
This shift is probably going to lead to a healthier loan market, Mr. Donnelly said.
Analysts and investors attribute the Federal Reserve Boards first rate cut on Jan. 3 as the jump-start for the junk bond market. By the second week in January, they say, the spreads between high-yield bonds and the benchmark Treasury were at historic lows, indicating a renewed appetite for risk. Just a few months ago, spreads were at historic highs, indicating a flight to quality.
Interest rate cuts, coupled with the investors increasingly deep pockets and the quality of the companies issuing bonds, have contributed to the upturn.
The quality of the issues coming into the high-yield market is another selling point among investors. The credits are considered strong because they are from large-cap, well-known, seasoned issuers that can offer greater liquidity in the aftermarket than first-time, smaller credits, analysts said.
Furthermore, Joe Mirsky of the Offitbank junk-bond boutique said that bankruptcies investors biggest fear have basically run their course, making people less afraid to back high-yield issues.
The activity in the high-yield bond market has resulted in a net reduction in volume in both pro rata and institutional loans, Mr. Donnelly said. Bank tranches lost $335 million in January, while institutional tranches were reworked for a net loss of $140 million, he said.
In the fourth quarter there was a massive shift toward institutional investors from the pro rata market, accounting for some $1.2 billion flowing into the former, Mr. Donnelly said. Now that the high-yield market is open, both the institutional and pro rata pieces are shrinking on deals launched this year, a trend that should continue, he said.