One Reason Why this High Yield Cycle is Different

March 12, 2015

One Reason Why this High Yield Cycle is Different Photo

This week's chart, shown above, tracks the amount of leveraged buyout (LBO) activity over the last 15 years versus the aggregate dollar volume of merger and acquisitions (M&A). Two items stick out: M&A activity is at a post-crisis high and has accelerated in the year-to-date period, and there has been a dramatic decline in LBOs as a subset of the larger M&A environment since 2008.

At 5.6%, LBOs as a percentage of M&A activity in 2014 was well below the double-digit percentages registered in the pre-crisis 2003 - 2008 time period. There are several reasons for this including the extended period of caution in the capital market coming out of the depths of the financial crisis, increased regulatory scrutiny, banks' reduced ability and willingness to support highly leveraged transactions, and a more sluggish global growth outlook. Private equity/buyout funds have also been less aggressive buyers during the initial stages of the rebound; in fact, they have been better sellers of assets over the last two years given robust valuation levels.

During the current cycle, the bulk of M&A has been driven by strategic buyers looking to augment organic growth rates and take advantage of low interest rates. Debt-financed strategic M&A is much less problematic for the high-yield market than an LBO-led debt wave. In general, strategic M&A has been accretive to high-yield credit quality, as the increased size, scale and diversity associated with the purchases has more than offset any increase in leverage. Moreover, positive event risk exists for high-yield companies that are periodically targeted by investment grade entities, resulting in a higher-rated merged entity and occasionally bonds being tendered at a premium.

Key Takeaway: While there are other differences between this high yield cycle and others, the lack of LBOs ranks high as a distinguishing factor. From a macro perspective, the more benign M&A activity has contributed to the current extended credit cycle, now in its seventh year. It may also have positive implications for future default rates; the dollar values at risk from a few large deals are lower; the future maturity wall is more manageable; and fewer highly leveraged transactions correlates to lower corporate leverage, in aggregate.

Tags: Chart of the Week | High-Yield Bonds | Private equity | LBOs | M&A | Junk bonds | Post-crisis

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This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.  This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.

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