High-yield deals are testing the market and finding demand

PTAM

The high-yield municipal bond market is heating up two months into the year.

With strong investor demand and limited primary market supply, some speculative-grade deals that were shelved last year, and even at the start of this year, are returning to market or have already seen successful pricing.

While borrowers are eying the favorable market conditions, buysiders said their credit standards remain tighter than in recent years.

Houston, Texas, is set to bring a pair of speculative-grade bond deals totaling $400 million for United Airlines, Inc. to market the first week of March after the deals were pulled last year. The two deals were part of a larger $522 million transaction that saw only one tranche — $277 million of airport system special facilities revenue refunding bonds — price.

A $168 million transaction for Zeta Charter Schools, Inc., brought by the Build NYC Resource Corp., that struggled to clear the market in the fall priced last week was 10 times oversubscribed and then the bonds traded up another 9 basis points on the break, according to Birch Creek Capital.

"The school is very pleased with the result," said a spokesperson for Baird, the underwriter on the deal. The original schedule was "adjusted to accommodate standard approval procedural steps," the spokesperson said. "Once those were completed, the transaction proceeded smoothly."

A $241 million sale for PRG Casa Properties LLC, a student housing project priced through the Miami-Dade County IDA, was able to clear the market after the team revised the structure to include a 10-year put and added an underwriter.

In January, a $634 million deal for RiverSpring Health Senior Living, Inc., also brought by Build NYC Resource Corp., represented "the first true test for the high-yield market this year," and signaled that investor demand was back, said Justin Horowitz, senior portfolio manager at Birch Creek.

"The combination of limited supply and renewed demand has driven outsized subscription levels and sharp price moves when new issues break, particularly in newer or less widely held credits," Horowitz said in an email. "With the broader credit environment remaining relatively benign, we expect stress to remain idiosyncratic and concentrated in select names and sectors, which should support continued flows into high-yield funds as investors grow more comfortable earning additional spread by moving down the risk spectrum and, ultimately, encourage more speculative issuance to meet rising demand."

On the issuance side, year-to-date high-yield volume totals about $2.3 billion out of total issuance of $68 billion, Barclays said in a Feb. 20 client note.

On the demand side, the week ending Wednesday marked the seventh straight week of positive fund flows this year. High-yield mutual funds saw inflows of $304 million, bringing the total of $2.57 billion of inflows year-to-date, according to LSEG Lipper.

The high-profile struggles of Brightline Florida's passenger train have weighed on the high-yield sector, pulling down some fund returns last year. American Dream mall, another high-profile credit in the unrated market, also contributed to high-yield underperformance last year, according to Barclays. The June collapse of the Easterly RocMuni High Income Municipal Bond Fund stunned the market, though there was no larger contagion from the collapse.

Unlike the investment-grade market, high-yield deals have a concentrated buyer base, making them very reliant on fund flows and market environment, said Chad Farrington, co-head of municipal bond investment strategy at DWS.

"If money is not coming into mutual funds, then there's going to be less demand. And buyers are going to get a little picky," he said. Strong flows and limited supply — as has been the case so far this year — may grease the skids for some deals that otherwise would not get done.

Some larger speculative deals that were shelved last year, like a $1.2 billion American Tire Works transaction and $561 million New York casino transaction issued by the Sullivan County Resort Facilities Local Development Corp., are driven less by market timing and more by investors who were put off by the credit or deal structure, buysiders said.

Some of those deals, based on fundamentals, may not get done without significant changes, Farrington said. "Let's say that they add security, they add a parent company guarantee, or do something that's pretty drastic. Just bringing it back in as it is, probably [will] not happen, even if you do get the perfect market conditions."

Some high-yield deals take time to come together, so the team may not be waiting for perfect market conditions, Farrington said. "An issuer may have been working on a new deal for the last six months, so they will try and bring it no matter what the market looks like."

The American Tire Works deal may still return to market. "Our client continues to work on the project and address issues that have arisen," said Yaffa Rattner, senior managing director and head of municipal credit at Hilltop Securities, the underwriter. "When it is appropriate, the client will reengage the market," Rattner said.
 
While demand so far this year has been strong, investors remain focused on protecting themselves, said Mohammed Murad, head of municipal credit research at PTAM.

"The buyside remains diligent about credit structure and bondholder protections as seen from the various 'supplements' put out by certain deals," Murad said. "The theme that continues to stick across deals is 'the cost of things,' which may ultimately drive borrowing costs higher once capitalized interest, debt service reserves and other liquidity requirements are baked into the size of borrowing."

Karen Pierog contributed to this report.