Slowly but surely, the grease that lubricates Wall Street’s deal machine is flowing again.
A significant improvement in the credit markets since late March is emboldening more companies to undertake acquisitions and share buybacks that will be financed largely with debt.
At the same time, banks and Wall Street securities firms, which have freed up space on their balance sheets to lend again, are encouraging corporate borrowers to take advantage of lower interest rates and hospitable market conditions while they can.
”Most of us are anticipating two steps forward, one step back and carefully watching where the markets can handle deals,” says Tyler Dickson, who oversees capital raising at Citigroup Inc., adding that ”the trend is heading in the right direction.”
In the past few weeks, U.S. corporations unveiled a string of deals that will be paid for with bonds or loans. Cablevision Systems Corp.’s $650 million purchase of Long Island newspaper Newsday will be financed with debt arranged by Bank of America Corp. Hewlett-Packard Co.’s proposed acquisition of Electronic Data Systems Corp. for $13.25 billion is also likely to be funded using mostly debt, according to Fitch Ratings.
Satellite-television operator DirecTV Group Inc. recently raised $2.5 billion from bonds and loans in the biggest ”high yield,” or junk, bond sale since October; it will use the cash to buy back shares.
And a number of companies in the booming energy sector are tapping the junk-bond market for cash, encouraged by stronger investor interest in companies that can churn out robust profits in the coming months.
”There’s no question the tone in the market is getting better,” says Jim Casey, co-head of leveraged finance at J.P. Morgan Chase.
He adds, however, that ”there is some concern that this might be a short-term window of opportunity for issuers, since investors are still very focused on default rates and the potential severity of a recession.”
Banks and debt investors are treading carefully. While they are more open to financing deals where one corporation buys another, many are still somewhat reluctant to fund leveraged buyouts by private-equity firms.
Companies acquired in leveraged buyouts are often loaded up with a lot more debt relative to their cash flow, increasing their risk of default.
Although debt issuance is picking up, the activity is so far largely limited to bigger companies or those with relatively strong balance sheets. The average size of new junk-bond offerings is half of what it was a year ago, and bankers don’t think the market can yet stomach multibillion-dollar debt sales.
There are some encouraging signs regarding the leveraged-buyout overhang. The pipeline of unsold leveraged loans and bonds has shrunk to roughly $100 billion from more than $300 billion last summer, alleviating some strains on the market.
Meanwhile, the additional interest that most junk bonds pay over Treasury bonds has fallen by nearly two percentage points since mid-March to around 6.8 percentage points, according to Merrill Lynch data.
And a handful of firms, including power company AES Corp. this week, recently issued junk bonds with interest rates below the key threshold of 8 percent, the first time that happened in many months.
Still, caution reigns. Investment banks, which incurred big losses after selling a lot of buyout debt at heavily discounted prices, are committing only to deals they can underwrite at a profit. And investors don’t want to be caught wrong-footed if corporate defaults spike.
”Risk tolerance is still pretty low,” says Daniel Toscano, a managing director of leveraged and acquisition finance at HSBC Securities in New York.