Barrie Whitman: Changes In The High Yield Market

The last two years have seen a change in the dynamics of the high yield market, which has been brought about by structural as well as cyclical factors. At the height of the credit crunch, default risk fears reduced access to credit markets for all companies, especially those non-investment grade. Over the past two years, liquidity has steadily re-entered the system as we move towards a capital markets lending model - where banks intermediate between borrowers and investors rather than lending themselves. By Barrie Whitman, Head of High Yield Threadneedle

The structural change to the market has arisen from the credit crunch itself; in the inquest into the cause of the crisis, it became evident that banks were insufficiently capitalised. As a result, banks were unable to lend for fear of turning a perilous position into an outright collapse, should borrowers default. A consequence has been an increase in core capital requirements - the passing of updated legislation in the form of Basel III. The divestiture of riskier assets by banks has also improved their balance sheets. Banks are healthier now because of improved regulation and there is thus an increasing willingness to lend and bring issues to the market.

Stimulus from low policy rates at central banks as well as non conventional measures such as Quantitative Easing has also supported the return of liquidity. In response to this stimulus, yields dropped and the cost of borrowing decreased. This acts as incentive to corporates to issue, thus stimulating and reviving the high yield market. VimpelCom recently raised the biggest high yield offering from Russia since Lehman Brothers collapse froze credit markets.

The changing dynamic also results from an increased necessity on the part of corporates to refinance. During 2004-2007, the high levels of merger and acquisition activity by corporates and private equity firms was funded through easy credit markets and loans. With an average term of between 4-7 years, these bonds and loans now need refinancing, which has forced corporates back into the high yield market. Furthermore, as other companies see that the market is functioning again they are drawn back in to secure their balance sheets for the future.

With the capital market functioning again and with economic environments recovering, the focus of company management has returned to operations rather than these external distractions. A corollary of this is that companies are focusing on the need to have a stable balance sheet amidst the uncertainty that exogenous factors such as peripheral sovereigns bring. This has been evident in the cases of Cirsa and Ono, both of whom have refinanced existing deals at a small premium to benefit from the security of a stable balance sheet.

An active capital market for high yield issuers gives: banks the ability to manage exposure effectively; companies the benefit of improved lending terms and better regulated capital markets, and; ultimately, investors the benefit of increased activity.