When S&P took the unprecedented step last week of placing the U.S. on negative watch for a ratings downgrade from its once-unassailable triple-A perch, investors reacted the same way they have all year to the drumbeat of bad news: With a yawn.
Seems like nothing will stop the bull market in both credit and equities. Not three wars, trillion dollar deficits, 9% unemployment, $5 gas prices, earthquakes, tsunamis, nuclear meltdowns, sovereign defaults, or snoozing air traffic controllers. Short of Snooki taking over the Fed Chairman's seat ("She's tan, she's fit, she's ready"), we don't see the "bid 'em up" momentum ending anytime soon.
Certainly it's not slowing cash in-flows into retail loan funds, which saw another $532 million (per Lipper FMI) exiting muni and mutual accounts. That brings the year's total to over $12 billion, further exacerbating the technical imbalance between too much cash chasing too few deals.
The "too few deals" part of that equation may be changing. Refinancings, repricings and dividend recaps – features of the frothy first quarter, but stalled during the geopolitical turmoil – are resuming with some pretty hefty candidates. IASIS, Manitowoc, and Owens-Illinois are all over $1 billion in size. Frac Tech Services, a new Asian fund LBO, will add $1.7 billion to the pipeline.
Covenant-lites also seems poised for an upswing. LCD says that year-to-date cov-lite volume is a whopping $30.3 billion, up from a measly $1.7 billion for the same period last year. Besides IASIS, Neiman Marcus is shopping around for a $2 billion refi.
While you're at it, add second-liens to the list of comeback kids. While volume is nowhere near the heady days of 2006-07, second-lien structures are finding willing buyers. For investors, the attraction is yield; spreads for the first quarter averaged L+975, including floors and OID. Issuers prefer second-lien to mezzanine, which is more expensive (12% cash plus 3% PIK), and typically carries higher prepayment penalties.
The WSJ reports hedge fund AUM are restored to (and predicted to beat) the record $2 trillion levels set just before the credit crunch three years ago. Hedge managers again have plenty of buyers looking for yield and willing to stomach more risk to get it.
If you thought scary headlines would hurt prospects for 2011 being a banner in the credit markets, think again. BoA Merrill Lynch forecasts leveraged loan and high-yield bond issuance to hit $300 billion and $325 billion, respectively. That's well ahead of last year's numbers of $233 billion for loans and $284 billion (a record) for bonds. Just imagine where we'd end up with a little good news.
Market veterans confide their amazement how deal activity is motoring through all the negative economic fundamentals. On the other hand, corporate earnings, while hardly robust, continue their steady upward trend. And both interest rates and inflation remain comfortably low. And, of course, there's all that cash burning holes in investors' pockets.
Despite its frayed reputation as a prudent fiscal manager, no one believes the U.S. itself is headed for junk status. But we're certainly filling up on the stuff.
Randy Schwimmer is senior managing director and head of capital markets with Churchill Financial.
