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By Marine Cole
The future is suddenly looking more worrisome for highly-leveraged companies.
They may have been able to survive the recession so far, thanks especially to the ability to refinance their debt, but the recent pull back in the high-yield corporate bond market will make it harder going forward.
The result is that many companies are putting funding plans on hold, which could impact their ability to refinance debt and ultimately to stay alive.
The junk bond market was on a roll for most of 2009 as it returned about 50 percent to investors. But in recent weeks, several warnings signs have appeared, as Fitch Ratings noted in a report Friday.
Several new bond issues have began trading in the secondary market below issue prices, and numerous recent deals have been either downsized or pulled from the market altogether.
At least three deals have been downsized between Jan. 20 and Feb. 9, which hadn't happened in several months. Energy Transfer Equity pulled its $1.75 billion transaction on Jan. 22 and since then five more deals have been pulled.
Fund flows into high-yield mutual funds have also slowed down significantly in recent weeks and even gone into negative territory. There was about $1 billion in outflow in the week ended Feb. 10 for instance.
Fitch believes these figures could be a signal that investors are beginning to consider the risk/reward trade-off to be less attractive in the high-yield market, particularly given the specter of higher interest rates in the coming weeks.
"Everyone saw the momentum and some people are starting to have second thoughts," Jeff Wallace, managing partner at Greenwich Treasury Advisors and an advisor to CFOZone.com, said in an interview.
He said problems in so-called PIIGS countries - Portugal, Ireland, Italy, Greece and Spain - are impacting debt markets in the U.S. and causing investors to rethink their approach to risk.
And while some experts may see a double-dip recession caused by sovereign risk, Wallace believes the recovery was destined to be short lived because it did little to reduce the leverage in the system. "There are a lot of highly leveraged companies out there," said Wallace, adding that the system has yet to fully digest the excessive leverage that built up, especially as a result of private equity transactions that piled debt on many companies in 2006 and 2007."Deleveraging is an ugly process," he noted.
There aren't that many ways for companies to reduce leverage, he noted. They can either pay off their debt, which is becoming more and more challenging as a result of declining access to the bond market. And continued problems in the housing market and high unemployment are dampening consumption, which is necessary to produce the cash flow that companies need to pay down debt.
The other way to deleverage is to go bankrupt, according to Wallace.
"It takes three to four years to deleverage," said Wallace, citing a finding in a recently published book entitled, "This time it is different: eight centuries of financial follies." "People can always survive for one year or 18 months."
But only the strongest companies can survive high debt levels for longer than that, he said. And the recent deterioration of the high-yield bond markets suggests we may be about to see those separated from the weak.
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