So is the High Yield Market Open or Closed?

Welcome back, and time for another post given 1) the debate over whether or not the High Yield Debt market is closed and 2) speculation over the weekend that things aren't looking good at Credit Suisse.

Back in July 2007, former Citi CEO Charles Prince said the following regarding financing leveraged debt during good times: “When the music stops…things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”  

Ya that wasn’t good timing at all. Quickly after that quote, the great financial crisis started to unfold.

This quote was later reworded into one of my favorite wall street movies, Margin Call, where CEO John Tuld of the unnamed investment bank central to the story laid out the following: “I'm here for one reason and one reason alone. I'm here to guess what the music might do a week, a month, a year from now. That's it. Nothing more. And standing here tonight, I'm afraid that I don't hear - a - thing. Just... silence.”

That quote of course is from a movie (not real life) – so what’s the real scoop? People are suddenly calling for the end of Credit Suisse this weekend (more on this at the end of the newsletter given that for now it's unsubstantiated and just a meme) and there’s a lot of commentary that the HY market is closed for business.

But is the HY market closing for the year? Or is something else happening? The HY market may just be rejecting deals with tougher docs, questionable sponsors, and softer stories and asking for higher yields to compensate for greater risks, but it seems like a lot of the HY community thinks most deals are now facing a shut door.

One of the tell-tale signs you can see to symbolize incoming distress, or a recession, is LBOs struggling to get done and the HY/Lev Loans market going quiet. When deals do get done, it usually involves the original issue discount (OIDs) widening out to a steeper discount to the debt’s face value. As seen below, the number of wider OIDs are starting to increase materially in 2022 in order to get deals done.

Some History on Deal Flexing/Wider Deals:

When times get more challenging, deals flex wider and terms tighten to attract more investor demand. As seen in 2001-2002, 2007-2008, and in periods of difficulty over the past decade, OIDs will widen to reflect a tougher deal/a tougher market environment.

Let's look at a recent example. Think about this deal in April 2020, when the market was totally closed. Texas Restaurant Billionaire and Houston Rockets owner Tilman Fertitta sought a $250mm TL for his Golden Nugget casinos and Landry’s Inc. restaurants. During the onset of covid-19, all of these businesses were forced to shutdown, driving an immediate need for liquidity. I recall this deal in particular, because it was pretty much the canary in the coalmine in the debt market as everyone was trying to perceive the risks associated with covid-19. To entice investors, the TL was offered at a L+1400 spread at an OID of 96 (all-in yield >15%). This was quite the change to a L+250 spread they received on a $200mm dividend recap only a couple of months earlier and goes to show how quickly the high yield/leveraged loan market can turn on you.

Things can get hard for banks when a deal is completely underwritten (arrangers commit to the entire amount). Banks are usually getting investors to subscribe to the entirety of the loan/bond, but in more challenging times, a deal can get “hung” and stuck on the bank’s balance sheet, restricting their potential ability to lend further. Even if they are able to syndicate, having to sell at a larger than expected OID can feel like getting a pie to the face. For example, if the OID widens from the traditional 99.5 to let’s say 95, that’s an additional 4.5 points that the bank that underwrote the deal has to eat. So when a deal like Citrix takes a bigger than expected loss, or a deal like Brightspeed gets stuck on your balance sheet, your incentive and ability to lend further is going to decrease materially.

Back in 2007, there were a significant amount of deals that struggled to get done. $22B in debt to finance the buyout of Alliance Boots, automaker Chrysler, power giant TXU, and processing firm First Data hurt the balance sheets of big banks such as Citigroup and JP Morgan. A lot of the hung deals were underwritten, with limited ways to easily syndicate.

LyondellBasell, the chems giant I called out in my article about some of the best distressed bets made, had to price paper in December 2007. Bookrunner Citigroup was struggling, so Apollo was able to get $1.4B of bank debt for 80 cents on the dollar! Citi had to take a 20% hit to sell that paper to Apollo – ouch (Off track, but the deal did become a homerun later on though – with Apollo’s $2B investment turning into $14B in value by 2013).

Let’s talk about what’s going on currently:

Late summer can sometimes be pretty slow to begin with, but it wasn’t an encouraging sign to see in late July that DB and UBS lost $200mm in their syndication of CD&R’s $5.8B buyout of Cornerstone Building Brands. Overall in 2Q22, the six largest US banks took a $1.3B hit on syndicating leveraged loans.

This brings us to Citrix: In January 2022, software firm Citrix agreed to be taken over by Elliott Management and Vista Equity for $16.5B and then merged with Vista portfolio company, Tibco Software. On September 21st, 2022, the sale of the $8.55B in loans and bonds finally got done after months of delay – but the syndicate had to take a hit. With $4.55B of term loan pricing at S+450 at an OID of 91 (wide of initial talk of 92-93 OID at S+450) and the $4B 6.5% secured bond for 83.6 cents at a yield north of 10% (high 8% range at 84.620-85.695 was initially floated), BofA, CS, and GS took a $700mm hit on the sale of debt related to buyout. Elliott, one of the sponsors, had to speak for $1B of the bonds too to make the deal work!

The rest of the capital structure included a $3.95B 2L (GS is leading this) and a $2.5B loan that banks held on the balance sheet. BofA, CS, and GS are the ones mainly eating it here, but the group involved 30+ banks who are also taking a bit of a punch to the face. The visual from Reuters below demonstrates how big of a deal this was:

Additionally, this chart from Bloomberg does a great job laying out how the going rate for paper changed since the deal initially got announced.

And now most recently - Brightspeed: In August 2021, Apollo entered a deal to buy broadband and telecom services provider Lumen (referred to as Brightspeed) for $7.5B. BofA and Barclays led the deal to sell the $2B term loan and $1.9bn in senior unsecured debt – but the syndication was unsuccessful. On September 29th, 2022 the notes and term loan ($5.5B of secured debt) associated with the transaction were pulled from the market. The TL being marketed at 92 cents at S+500 and the bond marketed at a 8% coupon and 10% yield was not sufficient for the lender community. There were however risks associated with the deal on the docs side and regarding the capital intensive execution risk to move from copper to fiber. It was a little non-traditional too to see Apollo having 60% of their $3B equity check provided by back leverage via a $1.9B five-year loan from banks. However, the deal is still closing in early October with Apollo equity + committed financing. The banks, mainly BofA and Barclays, are now stuck with this debt on their balance sheet though.

So what's the grand total? According to Bloomberg, banks now have to hold $11B in buyout debt that was supposed to be syndicated out.

Given the recent volatility and this hung deal, some are making the call that the HY new issue market is shut for the rest of the year. There’s a lot of reason to think this may happen given the sudden rise in interest rates makes pricing a deal challenging and debt stuck on a bank’s balance sheet hurts the ability to take on the risk of syndicating other buyouts. However, Brightspeed may just be a one off given sponsor + docs; but guess we’ll see soon enough. Here's a bold take below though:

So what else is on the pipeline? There's still over $8B in paper that was underwritten for Elliott and Brookfield’s buyout of TV rating firm Nielsen and $5.4B in debt for Apollo’s buyout of auto parts company Tenneco. Also imagine if Elon has to buy Twitter and Banks have to try syndicating debt for that in this environment? Lol. According to DB, post Citrix, there’s still $32B in leveraged loans and $23.6B in high yield bonds that need to be syndicated.

What does the HYH Insta Community think? This may be one of the cooler things about running the account, I have the opportunity to talk credit and markets with very smart people from different parts of the market. I got over a hundred replies, so I slimmed down the thoughts below. Here’s what we’re saying, and let’s start with the more "optimistic" thoughts first to balance out all the negativity we've seen so far:

“There’s still some activity” thoughts:

• HY market isn’t closed – there’s a healthy amount of loan and HY cash balances out there. Not much on inflow side but obviously still $. Lack of primary suggests 4Q deals will come, but much wider. Rates are going to get worse, terms are going to get tighter, and it isn’t a borrower/investor friendly environment.

• Private markets are still open, public markets are looking tenuous at best.

• Large cap is closed. MM is open for business. (Issuers) are able to get better spreads, terms, etc.

• Private Credit is the only place where good deals are getting done, but they’re still down bad.

• Private debt is still putting money to work, banks happy to originate that financing.

• Public markets closed but think big private guys will step in at egregious economics.

• There is *some* appetite but only for high quality, secured, pre-subscribed risk.

• Def will be a slow 4Q, but 1Q will start to light up again.

• Not closed but not open at the levels people are used to.

• Not closed, pricing is just insane.

• Not closed. There will be some non-LBO deals in soon with juicy pricing.

• Never closed – there's always a way to find good trades.

Bearish thoughts:

• Brightspeed was the nail in the coffin for remaining new issue this year.

• Pipeline is (poop emoji), HY is f’ed.

• Hearing Citrix has hung the market – RIP to any LBOs coming market.

• Completely closed, each week gets worse and worse (via anon source in a financial sponsors group).

• Work in LevFin, markets are currently closed for new underwrites.

• Work in a large, distressed desk, we’ve been called to help offload.

• Extremely closed rn – hard to get anything done without stupid high OID.

• With a CS exec – can confirm they’re fucked and the end is imminent (HYH note – not sure if real but might as well include in case it is!).

• Syndicated market is completely dislocated and direct lenders are running dry too.

• Only the best deals have any hope of getting done at the moment. Many on hold.

• World is in a materially worse place, yet HY spreads are still well inside YTD wides. Pain to come.

• Dead until the new year.

• Will likely see more deals start to talk around Christmas.

• LMM deals are getting wrecked on new deal flow.

• A litany of small deals no longer work.

• London based – liability driven investments (LDI) having the most intense impact I’ve seen in my entire career.

• Closed in Europe – only deal in the market couldn’t cover the book at 10.5%.

• In Europe, the whole debt market is closed.

• Market is completely shut in Europe, no expectation it will recover soon.

So what’s going to happen now that people are freaking out over Credit Suisse? Will anything play out?

To be frank - we don't know enough yet to call this a "Lehman moment" - but a lot of the craze over Credit Suisse this weekend was sparked by the following: On Friday, September 30th, the CEO sent around a memo noting the bank is at a “critical moment” and that employees shouldn’t worry about the share price given the bank’s “strong capital base and liquidity position.” Usually it seems like a red flag if you have to say that. Twitter really picked up on it HARD this weekend, but 1) it was mainly a meme 2) the accounts that were taking it seriously were permabear accounts or general fintwit accounts that overexaggerate. Obviously though, there's some serious issues with the Company, and the stock certainly isn't doing well...

You obviously can’t make the equivalency yet – but it’s eerie how Lehman and Bears said similar things when they were on the verge. On September 8th, 2008, The CFO of Lehman Brothers noted that “our capital position at the moment is strong.” They filed a week later on September 15th, 2008.

Meanwhile, Bear Stearns, on March 12th, 2008 (only a few days before they filed for bankruptcy on March 16th, 2008) told Reuters “We don’t see any pressure on our liquidity, let alone a liquidity crisis.” So ya – when there is real systemic risk, things can move very quickly and dramatically.

While it feels too early to say we’re having a “Lehman Moment”, who really knows? Clearly, things can go from 0 to 100 real quick. We’ve certainly seen that happen a ton over the past 3 years. What happens broadly is going to be depend on whether our market, the high yield debt market can stay open. If the doors shut in the banking world - how long until the lender of last resort (not Apollo, the Fed) gets called in? Fingers crossed, but we're going to find out sooner rather than later.

That’s all for now, talk soon.

HYH.