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Jon Macaskill is one of the leading capital markets and derivatives journalists, with over 20 years’ experience covering financial markets from London and New York. Most recently he worked at one of the biggest global investment banks |
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So a boom in high-yield bond and leveraged loan issuance has provided a welcome bright spot for bank chiefs already worried about how investors will receive their quarterly results.
The resurgence in leveraged debt issuance could also make a contribution to market stability – another welcome result as sovereign debt worries resurface and gloom about the global economy spreads.
The revived leveraged debt markets are starting to see a return of some features such as covenant-light loans that were symptoms of the credit bubble. But both absolute rates and spreads on new deals remain substantial, which indicates a realistic alignment of interest between lenders and borrowers. And an orderly flow of new deals that serves to reduce bunching in the future redemption schedule for high-yield borrowers could be an important factor in keeping down eventual default rates and unemployment.
The leveraged loan and high-yield bond markets pushed through a number of symbolically important barriers in September.
US leveraged loans hit $20 billion for the month, marking the highest volume since the collapse of Lehman in September 2008, while high-yield bond year-to-date totals in both Europe and the US surpassed all existing full-year records.
Moody’s said that the global default rate for leveraged borrowers had fallen to 5% in August from 12.3% the year before, and predicted a slide in the rate to 2.7% by the end of the year, to be followed by further easing to 2% in 2011.
Then Fitch announced that the biggest speculative-grade borrowers in the US had ample cash available and had used recent quarters to amend and extend deals to ease near-term funding pressure.
Issuance is expected to remain brisk. Some of the new deals in the US are being driven by a short-term concern that dividends will be taxed at a higher rate from next year.
Private equity firms are accordingly looking to add debt to companies they own in order to pay themselves a dividend before the deadline.
That should be enough to ensure that there are plenty of US deals lined up for the fourth quarter, which is about as far forward as bankers tend to look.
And if new assumptions about relatively low default rates prove to be correct, a wave of further deals in early 2011 is likely, as more borrowers move to refinance existing debt or fund M&A bids.
A combination of healthy leveraged lending and bond-arranging fees and increased corporate finance activity would go some way to filling the expected hole in investment bank revenues from a further decline in fixed-income trading returns.
There is debate within the industry over how far fixed income, currency and commodities (FICC) revenues will fall from the record $180 billion racked up in 2009. Equities and corporate finance revenue growth might go some way towards filling the hole but FICC flows have come to account for such a dominant proportion of revenue for the top 15 investment banks that some fixed-income markets will have to grow to keep broad returns looking healthy.
Credit trading – and particularly high-yield credit – offers the best hope of picking up some of the slack, as sectors such as rates and FX remain substantially below 2009 levels.
High-yield credit trading faces regulatory issues. The arbitrary decision in the Dodd-Frank US regulatory reform legislation to force banks to place their high-yield credit derivatives trading operations in separately capitalized subsidiaries is likely to have a short-term effect on liquidity in the default swaps that are used to hedge bond and loan deals, and to create basis-swap packages.
High-yield credit derivatives trading was already concentrated with a few big dealers, however. Swap end users might feel some frustration about a rule that serves to entrench this oligopoly but the big banks are likely to absorb the cost of placing high-yield default swaps along with equity and commodity derivatives in new subsidiaries and then try to recoup their money by keeping bid-offer spreads wide.
As the Dodd-Frank debate was coming to its conclusion in June the SEC lost a landmark case on insider trading via high-yield default swaps. The decision was overshadowed by the passage of legislative reform but it set a precedent that effectively leaves current freewheeling practices in the high-yield market untouched.
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The SEC and other regulators around the world are likely to persist in their attempts to make derivatives insider trading cases stick but dealers and investors can continue to keep open their relatively informal lines of communication for now. That in turn should keep the high-yield underwriting and trading wheels turning.
Pure underwriting fees from leveraged loans and high-yield bonds are not a big contributor to investment bank bottom lines. They offer a mid point between the derisory fees offered for investment-grade debt deals and the wider margins for equity offerings, however.
High-yield issuance can also be used to move up broad fee rankings and cement a perception of market leadership.
Bank of America Merrill Lynch had managed to supplant JPMorgan at the top of the global debt capital markets revenue league tables by the end of August, for example, in large part because of its drive to issue high-yield debt.
If the issuance trends of September continue – and in particular if there are a few more jumbo deals – there is every chance that the global high-yield debt underwriting revenue pool for banks this year will be around $5 billion.
That number has to be placed in context. It is roughly the amount that Goldman Sachs is expected to earn from rates trading in 2010, for example. The trend is firmly up, however, and not just from the depths of 2008, but also above 2006 and 2007 totals. That alone will help to ensure that banks keep pushing hard to win high-yield market share in 2011.
