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Low-Quality Junk Deals Dominate

High-yield investors spent much of the year fighting for allocations in low-quality deals in a bid for yield, while at the same time complaining about loose covenants, tight pricing and the use of proceeds.

High-yield investors spent much of the year fighting for allocations in low-quality deals in a bid for yield, while at the same time complaining about loose covenants, tight pricing and the use of proceeds. Triple-C issuance comprised 18.3% of new issuance with a record $26 billion of triple-C paper entering the high-yield market through the end of November, according to data from Merrill Lynch.

"In absolute terms, $26.2 billion is by far the largest value we've seen in that category," said Oleg Melentyev, associate at Merrill, adding the previous record was $15.3 billion in 1998, which constituted 11.6% of issuance. However, the 1998 number is somewhat distorted because unrated high-yield issuance that year was substantially higher than it was this year, and companies selling unrated bonds presumably did so to avoid a triple-C rating. Beyond just the total volume of triple-Cs, pricing on high-yield deals reflect investor appetite. The average price on a high-yield bond in the Merrill high-yield index, which comprises around 1,800 bonds, is 105 cents on the dollar, versus 78 cents in 2002.

While investors clamored for allocations in new issues, they whined all the way about terms and pricing, with some even threatening a buy-side strike in the middle of the summer. The threats came after a series of deals, including paper from Duane Reade, Refco Group and Loews Cineplex Entertainment, traded down in the secondary market after being priced tightly (BW, 8/2).

But, the strike never materialized. Despite getting burned by dividend deals from the likes of BCP Caylux Holdings Luxembourg, which issued $1.2 billion of paper in June with loose covenants followed by more debt to pay a dividend to parent The Blackstone Group (BW, 9/20), investors still swallowed loose deals whole. They balked at the liberal restricted payments basket on K&F Industries' $365 million issue last month, while whining that their allocations were too small (BW, 11/8).

"It was a feeding frenzy out there," commented Marty Fridson, ceo of FridsonVision, noting with fund flows increasing into high-yield and refinancings comprising much of the new issue market, net new supply far from satisfied investor demand. "It was a signal for the underwriters to call on all the lowest-quality issuers [to come to market]," he said. Fridson added it's hard to fault them for that.

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