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Junk bond bankers pin hopes on M&A surge
December 2, 2016 / 3:32 PM / in a year

Junk bond bankers pin hopes on M&A surge

NEW YORK, Dec 2 (IFR) - An uptick in M&A activity should help bolster US junk bond sales next year, reversing a three-year decline in primary volumes for the asset class - or so bankers hope.

The prospects for stronger economic growth under a Donald Trump presidency has reignited hopes for a boost in debt-fueled acquisitions, including leveraged buyouts.

That should offset a likely decline in refinancing activity following the recent spike in US Treasury yields and expectations of more aggressive monetary tightening by the Federal Reserve.

“The increasing rate environment will probably put a damper on the amount of refinancing next year,” Marc Warm, head of US high-yield capital markets at Credit Suisse, told IFR.

“But at the same time I would expect M&A financings to increase driven by the perception of better economic growth from the perspective of corporate boards and private equity sponsors.”

Warm expects US junk bond supply to hit US$220bn next year, roughly flat to 2016 levels, with acquisition-related financing increasing to 30%-40% of total issuance from around 25% this year.

Refinancing activity, on the other hand, should decline to around 50% of total issuance from just over 60% this year, Warm said.


Keeping primary volumes flat to this year’s level would be an accomplishment in itself, and reverse the trend of declining issuance since 2013.

At US$205bn so far this year, US high-yield issuance is down nearly 20% compared to 2015 and 38% lower compared to the US$329bn recorded in 2013, according to Thomson Reuters data.

Market participants are predicting that 2016 volumes will likely reach anywhere between US$210bn-US$220bn by year’s end.

Bankers are hoping that M&A driven transactions will bolster 2017 volumes, much like Dell’s acquisition of EMC and Western Digital’s purchase of SanDisk did this year after the sell-off in crude put the brakes on new issuance activity.

“The question continues to be where the supply is going to come from,” said Tim Broadbent, a managing director in Barclays’ leveraged finance syndicate, who also expects junk bond supply to remain roughly flat next year.

“M&A and LBO volumes are key to making this happen.”

Many spy opportunities for consolidations, spin-offs and buy-outs if Trump carries out promises to boost infrastructure spending and cut back regulations across a host of industries.

“You have a pro-growth president that has a different view on certain sectors like coal, mining, defense and healthcare,” said Brendan Dillon, co-head of global leveraged finance at UBS.

“There is going to be a lot of M&A activity associated with that repositioning.”


But such hopes may be premature. The recent rally in stocks has sent equity valuations to new highs, creating potential hurdles for public-to-private deals while strategic buyers still have plenty of cash on hand to outbid sponsors.

“These factors which have made high yield M&A financings harder are still going to be in place next year,” said Broadbent.

And growth prospects in the US are far from certain given elevated political risks and higher rates.

“Political headwinds are potentially very challenging in the coming year,” said Niklas Nordenfelt, a senior portfolio manager at Wells Fargo Asset Management. “To expect further expansion in the face of rising rates requires a fair amount of optimism.”

Bank analysts remain sharply divided on total return expectations for the US high-yield asset class, with JP Morgan forecasting a 8.3% gain and Morgan Stanley calling for a 2.7% loss. Total returns were just over 15% this year - outperforming both investment-grade corporates and emerging markets.

For now, however, bankers shrug off such concerns, noting that pipelines - particularly on the LBO side - have already showed signs of improvement.

“Although valuations will be high this will be offset by better growth prospects of the targets,” said Credit Suisse’s Warm. “Deals will be more expensive but there is a lot of dry powder out there.” (Reporting by Davide Scigliuzzo; Editing by Paul Kilby and Natalie Harrison)

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