Now Really Is The Winter Of Our Discontent ...

February 4, 2008

When I was 14, rambunctious and getting into things I shouldn't have been, my father grounded me for an entire holiday season. My sequestering began with a Thanksgiving release date, but I then got into more trouble, and he extended my punishment to Christmas. Believing this entirely unfair, I snuck out, got caught, and was sentenced to remain in custody until Easter.

If I didn't know better, I might believe my father held some sort of mysterious power over the leveraged finance markets as well.

After a cruel summer and a wishy-washy fall, the markets have trudged knee-deep into a bitter winter. Market players first hoped that Labor Day held the key to recovery; then, they set their sights on the new year. But with each passing season, it becomes ever clearer that the high yield loan and bond markets, held prisoner by a complicated mix of factors, will not reach freedom as easily as some expected. Of course, unlike the case of a teenager awaiting release from restriction, it seems downright silly to expect any one date to signal a reversal of market conditions, even if that date is Jan. 1.

January does represent new beginnings and has historically provided the leveraged finance markets with strong deal flow, as our front page story by Richard Kellerhals shows. Unfortunately, this January has not only disappointed, but it will go down in history as the worst the markets have seen in nearly a decade.

You see, the problem with hanging hopes on a date as a turning point is that the date doesn't change anything. It's like expecting the person you marry to reinvent themselves after the nuptials. Doesn't happen.

Yes, there has been movement of debt out of the pipeline since the fall. But bankers are still having trouble syndicating bulky deals, as the postponement of Harrah's, one of the more popular of the sizable LBO deals, proves. And the disconnection between the bankers' desired price and the price investors are willing to pay has only worsened.

With the LCDX hovering at 93 or 94, and many loans trading in the 80s, investors are forcing OIDs on primary loan issues ever lower (HYR, Jan. 28, 2008). (Harrah's offer of Libor plus 300 bps, with an OID of 96.5, simply didn't cut it.)

Meanwhile, spreads on the high yield bond secondary market recently reached 7.5% over Treasurys, the highest level in more than five years and close to the recession year of 2001. And the primary bond market has all but shut down.

One glimmer of hope comes from the fact that some LBO deals, with their boom time debt agreements, have taken themselves out of the pipeline. Still, while we can all hope to see a better spring, let's not count on Easter to offer resurrections beyond the one it's famous for. -CJC

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