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By: David Azarkh and John O’Connell, Simpson Thacher & Bartlett LLP.
The most appropriate word to describe the high yield market in 2016 is volatility. There were some rough patches when few issuers tested the waters—particularly during the first quarter—but over the course of the year, a number of windows opened up with favorable market backdrops for issuing new high yield bonds. For example, in February 2016 the United States saw a meager $8.6 billion of new high yield issuances, whereas April 2016 saw a robust $31.8 billion. The ebb and flow of 2016 was no different from 2015, with $38.4 billion of new high yield issuances in April 2015 and just a sparse $3.1 billion in December 2015.
After record issuance levels in North America and Europe in 2013 and 2014, the high yield market turned volatile in 2015 and into 2016, due in large part to falling oil prices and increased political and financial instability both in the United States and abroad. In the United States, new high yield issuance in 2016 declined for the fourth consecutive year to $229 billion, primarily due to commodity concerns, particularly with respect to defaults in the energy sector, which increased in 2015 and continued to rise in 2016. Throughout the year, investors remained concerned about macroeconomic weakness in many leading economies, the ever-present uncertainly around the timing of interest rate increases, and the potential for continued increased default levels in certain sectors exposed to commodity price unpredictability such as oil, natural gas, coal, and iron ore.
In addition, the Federal Reserve’s 2013 guidance to banks regarding limiting credit to finance acquisitions with high debt-to-EBITDA ratios continued to affect acquisition financing structures in 2016 and dampened the market for high yield bonds used to fund leveraged buy outs (LBOs). This policy has had a particularly disproportionate impact on acquisition financing strategies for private equity firms and their portfolio companies, which have historically relied on financing from banks as the primary source of acquisition funding, with such debt often refinanced in the high yield market. U.S. high yield issuers also grappled with important court decisions that have affected the ability of issuers to restructure their bonds outside of bankruptcy. The high-profile bankruptcy of Caesar’s Entertainment in January 2015, for one, gave investors heightened reason to proceed with caution before investing in bonds related to highly leveraged buyouts.
But 2016 also showed signs of promise for a high yield rebound in 2017. Notably, as issuers and investors adjusted to recent interest rate increases in the United States and stimulus measures from the European Central Bank, new high yield issuance volumes increased over the latter part of 2016. Notwithstanding widespread market volatility in December 2015 following the first interest rate increase by the Federal Reserve since the financial crisis, the U.S. economy has continued to expand and unemployment figures have continued to decline. In December 2016, another rate increase by the Federal Reserve signaled confidence in continued growth in the U.S. economy. Such rate increases are expected to continue in 2017. In addition, in the aftermath of the highly contentious U.S. presidential election, bond yield prices increased significantly, with investors seeming to show initial consensus that the incoming administration and Republican Congress could stimulate the U.S. economy if they follow through on their promises to invest in infrastructure, deregulate, and cut corporate tax rates. The effect of the new administration, however, remains to be seen. On the whole, most banks on the street expect an uptick in high yield volume in 2017, with the average consensus forecasting $237 billion in new issuances. In sum, the latter half of 2016 showed a few promising signs of life for the 2017 high yield market.
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David Azarkh is a Partner in Simpson Thacher’s New York office and a member of the Firm’s Corporate Department. David’s primary area of concentration is capital markets. David regularly represents underwriters, corporate clients, and private equity sponsors in securities offerings ranging from high yield and investment grade debt offerings, leveraged buyouts, initial public offerings and other capital markets transactions. He also assists companies with compliance, reporting, and establishing corporate governance programs. John O’Connell focuses his practice at Simpson Thacher & Bartlett LLP on advising clients on capital markets transactions. He regularly represents investment banks, corporate issuers, and private equity sponsors in connection with securities offerings ranging from initial public offerings, follow-on and secondary offerings, high yield debt offerings, and investment grade debt offerings.
For a detailed discussion on the use of high yield covenants, see
> COVENANTS: HIGH YIELD VS. INVESTMENT GRADE
RESEARCH PATH: Capital Markets & Corporate Governance > Debt Securities Offerings > Rule144A/Regulation S Debt Offerings > Practice Notes > Key Documents and Provisions
For guidance on the drafting of restrictive covenants and transfer provisions of indentures governing debt securities issued in Rule 144A (17 C.F.R. § 230.144A)/Regulation S transactions, see
> DRAFTING AN INDENTURE FOR A RULE 144A/REGULATION S ISSUANCE
RESEARCH PATH: Capital Markets & Corporate Governance > Debt Securities Offerings >Rule 144A/Regulation S Debt Offerings > Practice Notes > Key Documents and Provisions
For assistance in drafting a closed end indenture, see
> INDENTURE (RULE 144A AND/OR REGULATION S DEBT OFFERING)
RESEARCH PATH: Capital Markets & Corporate Governance > Debt Securities Offerings > Rule144A/Regulation S Debt Offerings > Forms > Transaction Documents