Heather Rupp, CFA, Director of Research for Peritus Asset Management, the sub-advisor to the AdvisorShares Peritus High Yield ETF (HYLD), analyzes credit fundamentals in the high yield market.
Between the very high premiums on many outstanding bonds and the low yields on many newly issued credits, there is plenty to avoid in today’s high yield market. There are also weaker credits that have deteriorating fundamentals or highly levered balance sheets that investors should also steer clear of. By looking into the credit fundamentals, the investor can evaluate the sustainability of the capital structure and assess factors such as use of proceeds. The use of proceeds can include dividends being paid to private equity holders or leveraged buyouts (LBOs). While we are not opposed to LBOs, as they can often produce very supportive private equity partners, what does concern us is when the capital structure is levered up to a potentially unsustainable level due to these buyouts or large dividends to equity sponsors.
For instance, back in 2006-2008, we saw this as private equity investors were leveraging up transactions at insane multiples, issuing a huge amount of bonds and loans in the process. The full effect of those actions has yet to be felt. Yet the bonds issued by these legacy leveraged buyouts (LBOs) are prevalent in both the high yield bond and loan indexes and the passive products that track them. Some of these companies have already gone through a restructuring (primarily bond exchanges) and we expect that more will do so in the future. Looking at a few examples of these LBO companies, the current debt multiples (net debt as a multiple of EBITDA, or earnings before interest taxes depreciation and amortization) are staggering.1