Total leverage finance and high yield issuance have hit record levels, but overall outstandings have hardly budged as the principal drivers of supply have been repricings and recapitalizations, according to the latest report of Morgan Joseph TriArtisan’s newly renamed Recapitalization & Restructuring Group.

James D. Decker, a managing director who heads the group, points out that demand is being spurred by new CLOs, legacy CLOs and retail inflows. However, he notes that in the absence of meaningful M&A activity the market is being characterized by increasing leverage, decreasing pricing and looser structure.

At the same time, the report suggests that “overheating of the high yield market could indeed lead to a bubble bursting.” This, it contends, “would not be dissimilar to the 2007 loan market that eventually choked on the volume of mega-LBOs.”

The report states that while 2012 high yield issuance at $350 billion was nearly triple the trailing 12-year average, actual yields were approximately half the 25 year average. And while noting that spreads at 591 bps closely approximate historical averages, it observes that “it is debatable if high yield bonds have ever been at more risk to rising rates.”

In the circumstances, MJTA suggests as a possibility a rebalancing of leveraged debt from bonds to loans that could possibly fuel a further loan market rally. Whether the result of an increasing rate environment or higher defaults, “loans become more favorable investments given their floating rates, greater seniority and covenant protections.” The result could be a loan-from-bond refinancing, which should drive even lower yields and looser structures for leveraged loan borrowers, the Report states.

In other areas, the MJTA Recapitalization and Restructuring Report observes:

• Sun-setting CLOs are expected to increase from under $20 billion in 2012 to approximately $60 billion in 2013, despite consensus forecasts of between $60 and $80 billion (up from $55 billion last year). On a net basis, 2013 should actually be a weaker year for CLO investment into leveraged loans, with spreads nonetheless being pushed to new lows reflecting demand for yield by retail and alternative investors.
• Competition for Asset Based Loans remains fierce, with fourth quarter average spreads pushed to new post financial crisis lows, breaching the 200 bps mark for only the second time and hitting that mark for the first time since the various European crises. Lenders continue to show willingness to “stretch” against more non-traditional collateral or even air balls, so long as the non-collateral supported pieces is both a small percentage of the overall facility and can be amortized quickly.
• For middle market borrowers with a minimum EBITDA in the $15 to $20 million range and strong operating trends, cash flow senior lending has become generally available at leverage levels as high as 3 to 4 times. Borrowers with sub-$15 million EBITDA are seeing new lenders enter the market, though the market is neither consistent nor efficient. Pricing can vary widely and terms often depend on the type of lender and their funding as the credit itself.

Morgan Joseph TriArtisan is an investment bank engaged in providing financial advice, capital raising and private equity investing. The firm’s services include mergers, acquisitions and restructuring advice, in addition to private placements and public offerings of equity and debt.