Leveraged loan sales plunge 57% as losses deepen: credit markets
Leveraged-loan issuance in the U.S. dropped 57.5 percent in the third quarter with losses mounting amid a faltering economy.
New issue sales fell to $50.6 billion from $119 billion in the three-month period ended June 30, according to Standard & Poor’s Leveraged Commentary and Data. Year-to-date issuance of $310.8 billion outpaces last year’s $233.4 billion figure. Losses on the outstanding securities deepened more than nine times from the second quarter to 4.8 percent in the three months ending Sept. 30, according to the S&P/LSTA U.S. Leveraged Loan 100 Index.
Investors pulled $6.47 billion from funds that buy floating-rate bank debt after the Federal Reserve pledged to keep benchmark rates near zero until mid-2013 to revive the world’s largest economy, according to EPFR Global. Investors fled from riskier assets as concern increased that Europe’s failure to contain the region’s debt crisis and a possible default by Greece would lead to a global economic downturn.
“When the market is backing up and investor demand softens, volumes fall as opportunistic issuers avoid the market,” Andy O’Brien, co-head of syndicated and leveraged finance at JPMorgan Chase & Co. in New York, said Sept. 28 in a telephone interview. “If you look at this month’s institutional loan calendar it’s almost entirely the underwritten M&A financings that have to close. Anyone who can wait will wait.”
Junk Debt Value
JPMorgan says that U.S. junk bonds and loans have value as many low-rated companies have the cash to withstand a slowdown, even as relative yields on the debt are at their highest level in more than a year.
Of the $19.4 billion banks have committed to finance purchases, $14.1 billion will be in the form of institutional loans, according to Barclays Capital. Institutional debt is sold mainly to non-bank lenders such as collateralized loan obligations, loan mutual funds and hedge funds.
Elsewhere in credit markets, a benchmark gauge of U.S. corporate credit risk rose to the highest level since May 2009 as Europe’s finance chiefs sought to prevent a Greek default and the cost of insuring German government debt climbed to a record. American Express Co. is marketing $1.15 billion of bonds backed by credit card payments in its first sale of the debt this year.
The Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, rose as much as 2 basis points to 146.2. As of 11:49 a.m. in New York, the gauge added 1.2 basis points to a mid-price of 145.4 basis points, according to index administrator Markit Group Ltd.
German Swaps
The credit swaps index, which typically gains as investor confidence deteriorates and falls as it improves, has increased from 136.2 on Sept. 27 as concerns mount that Europe’s sovereign debt crisis is worsening. The region’s officials prepared to meet in Luxembourg today to consider how to shield banks from the debt crisis and boost a rescue fund after Greece missed a deficit target for 2012.
Credit-default swaps on German debt closed at a record 117.3 basis points. The contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
American Express’s issue may sell as soon as this week, according to a person familiar with the offering, who declined to be identified because terms aren’t public. The New York-based company, the biggest credit-card issuer by purchases, last issued similar debt in April 2010, according to data compiled by Bloomberg.
Asset-Backed Securities
Offerings of asset-backed securities tied to the payments have plunged as banks use deposits to fund new loans. About $7 billion of the debt has been sold this year, compared with $8 billion in 2010 and $47 billion in 2009, Bloomberg data show.
Top-ranked debt tied to credit-card payments is yielding 75 basis points more than Treasuries, according to a Bank of America Merrill Lynch index. Spreads expanded to 82 basis points, or 0.82 percentage point, on Aug. 9, from 62 basis points on June 1, the data show.
American Tower Corp., the Boston-based wireless tower operator, plans to sell bonds in a benchmark offering, according to a person with knowledge of the transaction who declined to be identified because the terms are private. Proceeds will be used to repay existing debt and for general corporate purposes, the person said. Benchmark offerings are typically at least $500 million.
Loan Fund Flows
Money has continued to flow out of loan funds, which has put pressure on prices in the secondary market. Investors pulled $176 million from funds that buy floating-rate bank debt for the week ended Sept. 28, following outflows of $117 million the week before, according to EPFR.
“August was obviously a complete disaster in the loan market but it really was just driven by the technicals of the retail outflows,” said Elizabeth MacLean, a money manager at Pacific Investment Management Co., manager of the world’s biggest bond fund. “We continue to see very active prepayments and that helped in September to really provide a support bid.”
The S&P/LSTA Leveraged Loan 100 Index, which tracks the 100 largest dollar-denominated first-lien leveraged loans, fell 5.7 cents in the last three months to end Sept. 30 at 88.56 cents on the dollar. Prices on the index fell 5.34 percent in August, the biggest monthly decline since November 2008.
High-yield, high-risk, or junk, bonds and leveraged loans are rated below Baa3 by Moody’s Investors Service and lower than BBB- by S&P.
European Bailout
European lenders decision in July to provide a second bailout for Greece failed to allay investor concern that the region’s crisis would spread.
The European Central Bank was forced to start buying the bonds of Italy and Spain in August to stabilize the nation’s borrowing costs. The central bank is also lending dollars to euro-area banks, in coordination with the Fed and other central banks, to curb liquidity concern.
Even as money has been flowing out of the loan market, companies have been refinancing debt, putting cash back in the hands of lenders. Georgia-Pacific LLC, the tissue-maker owned by Koch Industries Inc., obtained $3.5 billion in new secured debt last week to repay all of its loan obligations.
Georgia-Pacific had $2.25 billion in term loans and a $1.25 billion revolving credit line, all due in August 2016, Bloomberg data show.
Georgia-Pacific Repayment
This level of repayments, “pretty much matched the new issues that have been priced in recent weeks,” said Pimco’s MacLean. “That’s really helped to stabilize the market in the last month and makes things feel better in general about the technical picture.”
Investors are demanding 7.35 percentage points more than government debt to buy U.S. speculative-grade bonds and 7.77 percentage points more than Libor to buy leveraged loans, JPMorgan analysts wrote in a Sept. 9 report. Those are near the highest levels for both markets since June 2010, they said.
Spreads on junk debt are implying a 50 percent chance of the U.S. falling into recession, compared with JPMorgan’s estimate of about 40 percent, the analysts said in the report. While the U.S. economic recovery is faltering, corporations are bolstered by strong balance sheets and reduced need to raise capital, they wrote.
‘Quality’ Sells Well
Higher-rated companies were able to lower the interest rates they were giving lenders on loans while lower-rated borrowers struggled to get deals done.
“Quality is selling really well in this market,” said JPMorgan’s O’Brien. “There is currently much stronger demand for BB financings versus lower rated credits.”
Sealed Air Corp., the maker of Bubble Wrap that is rated Ba3 by Moody’s and BB by S&P, was able to reduce the interest rate on a $790 million term debt by 25 basis points to 3.75 percentage points more than Libor. The loan was sold at a discount of 98 cents on the dollar.
Blackboard Inc., an education-software maker rated B2 by Moody’s and B by S&P, boosted the discount it sold $780 million of debt backing its buyout by as much as 3 cents to 92 cents on the dollar.
More liquid names bore a disproportionate amount of pain in the loan sell off in the quarter. Losses on debt larger than $1 billion was 4.6 percent, according to the Credit Suisse Leveraged Loan Index. Loans $200 million to $300 million pared 2.7 percent.
“There was a big differential between what the index has done versus larger facilities, showing that a lot of the pain trade for the quarter was built into larger, liquid facilities” said Jason Rosiak, the head of portfolio management at Newport Beach, California-based Pacific Asset Management, an affiliate of Pacific Life Insurance Co.