An expected increase in merger and acquisition activity could prove a positive to high-yield credit quality this year, speculate fixed-income market participants. With the recent rally in major equity indices such as the Standard & Poor's 500 and the Russell 2000, a firmer equity market this year could prompt continued M&A activity. This would boost credit if companies use stock to finance deals instead of debt, they said. "[If] the expected surge in M&A comes about through stock being used as currency, that would be a positive for credit quality," said Marty Fridson, ceo of FridsonVision, an independent credit research firm.
The equity-as-currency strategy would be friendly to bondholders, as opposed to other alternatives such as leveraged buy-outs. In a climate of cheap debt, levering up remains a tempting option for M&A activity but the recent equity rally has high-yield market participants hopeful the activity will use stock as its currency, a strategist added.
"There's a consensus high-grade credits will start taking on more leverage and one of the likely ways is to purchase a highly levered company," said the strategist. Industrial companies and those in sectors with low-capacity utilization are likely targets for roll-up activity, the strategist suggested.
As an example of how M&A can boost credit, Fridson pointed to the proposed steel industry merger between International Steel Group, Ispat International and LNM Holdings to create Mittal Steel. The deal is perceived favorably by both S&P and Moody's Investors Service.
Last year, M&A activity within the high-yield market caused Moody's to downgrade 49 deals for a total of $24.1 billion, while it upgraded 72 transactions worth $62.6 billion of bonds. Kamalesh Rao, economist at Moody's, expects frequent M&A activity to continue and for the resulting upgrades to outpace downgrades again this year. "We'll keep an eye on whether we're entering into a phase where M&A activity will damage balance sheets, but there's no indication we're entering into that sort of mentality," he said.