Leveraged Loans

US high-yield momentum evaporates late in Q1 as Fed policy comes home to roost

March 29, 2023

The long stalled high-yield issuance engine started to rev in the new year, as investors dared to hope the Fed could engineer a soft landing for the economy while vanquishing inflation. Volume of $20.6 billion in January and $14.4 billion in February marked the first back-to-back monthly totals in the double-digits since October-November 2021, according to LCD.

But the glide-path narrative fell apart as the quarter progressed and issuance nearly ground to a halt. At $40 billion, first-quarter volume was the lowest for the period in seven years, and the second lowest since the Global Financial Crisis.

The Feb. 2 session proved to be the peak for market sentiment, as a potent jobs report on Feb. 3 prompted a renewed cacophony of hawkish rhetoric from FOMC policy officials. From a 10-month low at T+370 that day, the option-adjusted spread for the S&P US High Yield Corporate Bond Index reached T+409 two weeks later. Spreads would then explode wider on the collapse of Silicon Valley Bank on March 10, which left the index approaching 500 bps in the turbulent weeks to follow.

In terms of dollar prices, the average bid for LCD’s 15-bond sample of liquid high-yield issues tracked higher from 86.06% of par at the final reading of 2022, to a 2023 peak at 90.96 on Feb. 2. That level would then plunge more than five points over the next four weeks.

Fund outflows
Against that backdrop, investors pulled assets from high-yield retail funds for six straight weeks through March 22, leaving the YTD net outflow at $15.2 billion. The $10.6 billion yanked from the funds for the two weeks to Feb. 22 marked the heaviest outflows for any two-week period since the onset of the pandemic in March 2020.

Back in October, strategists at BofA Global Research warned that “it is increasingly clear that the Fed will keep hiking rapidly until it gets stopped out by a financial market accident.” Indeed, while the Fed said it may have another rate hike in its locker post a 25 bps move in March, conventional wisdom suggests the Fed will let the banking crisis, and resulting tighter lending standards, do the bulk of its heavy lifting from here as it erects barriers to growth.

In the meantime, viable issuance windows are increasingly few and far between, as participants recoil from intense rate volatility and headline risk. LCD reported completed high-yield offerings in 13 of the 20 available sessions in January, or 65%, which was the same proportion as in January 2022. From there, the share of active sessions slid to 42% in February and 22% to March 24.

On a three-month basis, issuers utilized just 44% of the available sessions to March 24, down from 52% of the overall first-quarter sessions last year, and versus a stunning 97% utilization rate in the first quarter of 2021. (Issuers priced deals in 100% of the sessions in January and March in 2021, and 89.5% of February 2021 sessions.)

After narrowly leading the 2022 pace through February, high-yield issuance at $40 billion through March 24 has now fallen behind the comparable total for 2022, a year that went on to produce the lightest annual volume total ($102.3 billion) since 2008. Issuance was across just 53 completed new high-yield bond tranches from Jan. 1-March 24 this year, more than three-quarters of which were priced by Feb. 10.

First-quarter tranche counts were 70 in 2022, and a towering 227 in 2021. It’s the fewest new issues to come to market in a first quarter since just 28 issues crossed the finish line during the recession-wracked first three months of 2009.

Volume dial
Sliding high-yield volumes dovetail with a sharp year-over-year drop in leveraged loan issuance. The $89.5 billion of overall leveraged finance volume through March 20 was down 42.5% from the full first quarter last year, and down more than 73% from $334 billion in the first quarter of 2021.

In the early weeks of the year, issuers found favor in leaning on fixed-rate bonds for funding, including to take out leveraged loans. Bond-for-loan takeouts surged to $13 billion for January and February — already more than the $10.2 billion recorded for all of 2022 — before sliding to just $450 million in March.

Overall, refinancing was the primary driver of issuance for 63% of the deals priced in the first quarter, up from 53% for the first three months last year, and 55% in the fourth quarter. The average yield at issuance declined to 8.50% in January and 7.81% in February, from a post-pandemic high at 12.06% in October 2022, and a fourth-quarter average at 10.44%.

As issuers trimmed their exposure to loans in the early weeks of the year, secured bond placements made up 70% of overall bond issuance, building on a 55% share for secured prints in the fourth quarter. Over the five years through 2021, the peak quarterly share for secured bond pricings previously topped out at 39% in the second quarter of 2020, as issuers tiptoed back to a pandemic-blighted primary.

Amid souring market sentiment, the primary facilitated just one straight triple-C bond placement in the quarter, a $300 million issue of 13% five-year secured notes for Nine Energy Service on Jan. 19. In December, Jones DesLauriers Insurance Management Inc. snapped a nearly six-month shutout for triple-C bond placements, pricing $300 million of 10.5% senior unsecured notes (CCC/Caa2/CCC+) due Dec. 15, 2030 to repay second-lien credit facilities. The issuer returned to price a new offering on March 2, this time placing $500 million of 8.50% seven-year senior secured notes (B-/B2/B+) due 2030, backing a bond-for-loan takeout.

The risk-averse tone also culled the share of deals backing M&A and LBO transactions to less than 9% of overall issuance, down from 33% in the first quarter last year.

Featured image by Paul Brady Photography/Shutterstock

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