We strive to provide the highest level of client satisfaction, and handle each request with the utmost importance. We expect to respond to each request we receive within one business day of receipt.
Please note that trades cannot be processed via e-mail for security reasons. If your inquiry requires immediate assistance, please call us at
1-800-821-5129 (8:30 a.m.-6:00 p.m. EST, Mon-Fri).
Thank you for contacting Lord Abbett. A member of our staff will contact you between X:XXpm EST and XX:XXpm EST [today OR XX/XX/XXXX]. A confirmation has been sent to your email address.Close
Use this form to give us your feedback or report any problems you experienced finding information on our Website.
* Indicates Required Fields
Thank you for providing feedback.
(Second of two parts. Read Part I here.)
This last installment about the key questions facing high-yield investors addresses the prospects for more leveraged buyout activity and how it might affect bondholders. This issue and the outlook for fiscal policy may be important factors for investors who are deciding on the role that high yield might play in their portfolios going forward.
Q. Does the recent activity regarding leveraged buyouts (LBOs), such as the purchase of Heinz and the potential private-equity acquisition of Dell, suggest a return to excess leverage throughout the market?
Leveraged buyouts can saddle the acquired companies with debt, which often prompts credit rating downgrades, and can increase the risk of default. And the news about the Heinz acquisition and the potential purchase of Dell—both large transactions in the area of $23–24 billion—have raised concerns that another wave of LBOs could contribute to weaker credit quality throughout the market.
This LBO activity, however, needs to be put into context of where the market has been and where it is currently. This progression is underscored by the potential increase in leverage to about 4.5 times earnings before interest, taxes, depreciation, and amortization (EBITDA) if Dell were to be acquired. Conversely, in the benchmark LBO of 2007, Energy Future Holdings Corp. (formerly TXU Corp.) was loaded up with $36 billion in debt, which took the company’s leverage to 10 times EBITDA.1
The less egregious leverage amounts involved in the recent LBO activity reflect the liquidity that may be available to private equity firms and corporations. In the case of the Heinz LBO, Berkshire Hathaway contributed about half of the funding for the acquisition, with the remainder coming from loan and bond issuance.2
Overall, the leverage throughout the market continues to appear manageable for most companies. The debt that they carried in the fourth quarter of 2012 was 4.1 times EBITDA, which was still significantly lower than what existed during the height of the financial crisis, according to J.P. Morgan. (See Chart 1.)
Source: J.P. Morgan.
Although leverage ratios have risen recently, it is important to recognize the factors that have contributed to the increase. From the perspective of debt investors, there may be constructive uses of debt, such as financing new machinery, and there can be less constructive uses of debt, such as financing a special dividend to private-equity investors. And in that context, the recent increase in leverage is relatively benign, considering that it has been primarily driven by an increase in capital expenditures.3
The 9% annualized increase in capital expenditures in the fourth quarter of 2012 occurred as companies may have found less success boosting their bottom lines through further cost cuts.4 Therefore, many companies have reached the point where they are seeking growth through investment in capital goods, such as new machinery. And if these capital investments support companies’ cash flow, this may, consequently, improve their ability to continue servicing their debt.
Q. How will U.S. fiscal policy affect the economy and the high-yield market?
The inability of the federal government to agree on key elements of a balanced budget, overhaul tax policy, and restrain growing entitlement programs remains a source of uncertainty among debt issuers and investors. While both participants may have accepted this uncertainty for now, an abrupt change in any aspect of fiscal policy, however unlikely, could cause some volatility.
Still, the U.S. economy faces some headwinds that are remnants of the “fiscal cliff” resolution earlier in the year. This included higher marginal tax rates on high-income taxpayers and a resumption of the 2% payroll tax. In addition, the sequestration of $85 billion in federal spending may also constrain growth this year as it hits certain sectors, such as defense, particularly hard.
Despite these restraints, personal consumption and business investment remain resilient. Economic growth has also been supported by the recovery in the housing market, owing in part to the assistance provided by the Federal Reserve’s quantitative-easing programs and the environment of historically low interest rates. The resultant low mortgage rates have promoted home ownership and facilitated refinancing for many households, which in turn has further supported personal consumption.
The combined effect of fiscal drag and ongoing monetary easing could result in relatively subdued economic growth of about 2% gross domestic product (GDP) in 2013. Absent additional fiscal austerity in 2014, GDP growth could improve next year. If the economic expansion accelerates and unemployment rate improves toward the Fed’s target of 6.5%, the central bank may curtail its quantitative-easing programs. Indeed, in the minutes from its most recent policy meeting, some Fed members suggested an adjustment to its asset purchases within the coming months or by the end of the year. If the interest-rate environment “normalizes” in the near future, this may prevent a sharp acceleration in economic activity, with growth possibly accelerating to 3.5% in 2014.
In a gradually expanding economy, fears about inflation should linger, even if they are not fully realized. This continues to indicate that high-yield securities might outperform higher-quality, interest rate-sensitive securities until inflation reaches intolerable levels or the economic cycle changes course.
Investor interest in high-yield securities has certainly been justified in recent years, and that demand has raised a number of questions for investors as they consider the role of the asset class within their portfolio. While these issues are not trivial and deserve further monitoring, the market may continue to benefit from the major factor that has underpinned its performance in recent years, which is the strengthening of credit quality. And as long as interest rates remain near their historically low levels, corporate balance sheets should remain healthy and, most likely, validate high-yield as a long-term holding.
A Note about Risk: Investing involves risk, including the possible loss of principal. The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall. Fixed-income securities may also be subject to credit risk, which is the risk that the issuer may fail to make timely payments of interest and principal, and may be subject to call, liquidity, and general market risks. High-yield securities, sometimes called junk bonds, include higher risks than investment-grade bonds and carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. Longer-term debt securities are usually more sensitive to interest-rate changes; the longer the maturity of a security, the greater the effect a change in interest rates is likely to have on its price. Leverage, including borrowing for investment purposes, may increase volatility by magnifying the effect of changes in the value of a holding. The use of leverage may cause an investor to lose more money in adverse environments than would have been the case in the absence of leverage. The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. No investing strategy can overcome all market volatility or guarantee future results.
Dividends are not guaranteed and may be increased, decreased, or suspended altogether at the discretion of the issuing company.
Glossary of Terms:
A leveraged buyout is an acquisition that is financed with a large amount of debt that becomes the obligation of the acquired company.
Earnings before interest, taxes, depreciation, and amortization (EBITDA) may be used to analyze the true profitability of a company before financing and accounting decisions are factored into the results.
Gross domestic product (GDP) is the value of the goods and services produced by labor and property in the United States.
The debt/EBITDA ratio may be used to analyze how indebted a company is and whether it may be able to continue servicing its debt.