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High-yield investors welcome volatility

* Bankers predict US$15bn supply in next two weeks

* Pricing rises, but funding still attractive

* Investors enjoy some power over issuers

By Natalie Harrison

NEW YORK, July 31 (IFR) - High-yield bankers will unleash a barrage of deals over the next two weeks, even though big outflows and rate rise fears have put the asset class in its most volatile state in months.

With more than US$5.5bn of cash pulled out of high-yield funds in the last three weeks alone, according to Lipper data, most borrowers are having to pay up to get new trades over the line.

New issue premiums have risen to around 37.5-50bp on average from closer to 12.5-25bp before the recent softness, according to one banker, though there are still the odd exceptions.

Level 3 increased the size of its deal Tuesday to US$1bn from US$600m, and priced the trade well inside its curve.

PaperWorks Industries, which offered a much higher coupon, was six times oversubscribed even though proceeds paid a small dividend. Its new bond jumped by almost two points in secondary.

"Investors are using this as an opportunity to reprice risk, and we don't take it lightly that borrowing costs are higher," said AJ Murphy, global head of leveraged finance origination at Goldman Sachs.

"But when you think about where rates have been historically, it's still an extraordinarily attractive market for issuers. We are still advising most clients to take advantage of the market."

Long-term investors, who have been fighting for decent allocations over the past few months, have welcomed the volatility.

"Capital markets remain wide open for issuers even after the outflows," said Jim Keenan, head of Americas credit at BlackRock.

"If the market pulls back even more, people will step in to buy."

Even investors who have taken a step back from riskier trades of late say that high-yield is still a good bet.

Tony Ranaldi, a portfolio manager at DDJ Capital Management, has been buying lower yielding but safer paper, focusing on loan-to-value (LTV) ratios closer to 20% than to 50%.

"Risk is not being rewarded as much as it should be, and we have become more defensive," he told IFR.

" what we are seeing now is really just a blip in the context of what has happened over the past 12 to 18 months. The market has had an enormous run."

More value is definitely on offer right now.

Spreads on the BAML Master High-Yield Index fell to 335bp over Treasuries on June 23 from 400bp at the start of the year. After the latest correction, spreads have widened back out to 379bp over.

The yield-to-worst meanwhile has risen to 5.44%, having fallen to a record low of 4.83% on June 20, according to the Barclays High-Yield Index.


While that's a significant correction, it's nothing that the market hasn't overcome before.

When the Federal Reserve's tapering plans rocked the market last summer, the yield-to-worst went from around 5% on May 1 to 6.66% by the end of June.

And outflows at the time were massive - US$11.4bn in June 2013, according to Lipper.

This time round, however, many believe the outflows are due to the better-than-expected returns made this year, and consequently expect the pace of redemptions to slow.

By the end of June, the asset class had returned 5.7%, according to Bank of America Merrill Lynch data - more than what many thought would be achieved over the entire year.

Dan Doyle, a high-yield portfolio manager at Neuberger Berman, said overall the market was still very constructive.

"We're in an extended credit cycle, we do not expect the default rate to pick up for at least another two years and the economy is still growing," he said.

"It's hard to point to another asset class that is as compelling."

Equity markets, for example, are just as volatile. On Thursday, Wall Street's fear gauge - the VIX index - hit its highest level since April.


Even though Thursday turned out to be an ugly day for the market - cash bonds were down about half a point, with some new issues hit even harder - new supply is expected to keep coming.

Bankers see another US$15bn in high-yield deals hitting the market over the next couple of weeks, with acquisition financings making up a big part of that.

As yet there has been no formal announcement of the US$1.625bn bond backing the buyout of food retailer Safeway by Cerberus Capital Management, but Credit Suisse held a bank meeting for the US$4.5bn loan portion of the deal Wednesday, and the bond is expected to follow suit.

And there is plenty more acquisition financing to come.

"We continue to be very active in M&A financings, and we're certainly not shying away from underwriting quality deals," said Kevin Sherlock, co-head of leveraged finance capital markets at Bank of America Merrill Lynch.

(Reporting by Natalie Harrison; Additional reporting by Mariana Santibanez; Editing by Marc Carnegie)