Leveraged-Loan Spreads Climb to Record as Issuance Hits Post-Crisis Peak
The Federal Reserve Board Building
Andrew Harrer/Bloomberg
The Federal Reserve has kept the federal funds rate it charges to banks for overnight loans to an all-time low of zero to 0.25 percent since December 2008 to help stimulate lending.
The Federal Reserve has kept the federal funds rate it charges to banks for overnight loans to an all-time low of zero to 0.25 percent since December 2008 to help stimulate lending. Photographer: Andrew Harrer/Bloomberg
Investors are demanding the highest risk premiums to buy leveraged loans as companies borrow at the fastest pace since the beginning of the credit crisis.
New-issue spreads for high-risk, high-yield loans rated four to five steps below investment grade climbed to an average of 5.2 percentage points over lending benchmarks during the third quarter, beating the last record of 5 percentage points at the end of 2001, when the previous recession ended, according to Standard & Poor’s Leveraged Commentary and Data.
Banks arranged $249.6 billion of leveraged loans during the first nine months of this year, more than 2.5 times the 2009 amount and the most since 2007, according to data compiled by Bloomberg, as companies paid down a so-called debt maturity wall and leveraged buyout volume more than doubled. Investor demand for higher coupons is supporting a rally and higher returns for loans raised in 2010 even as the U.S. economic recovery slows.
“Issuance is going to continue to be heavy compared to the past couple years as two things happen: potential M&As, whether it be sponsor related or strategic, and companies looking to extend maturities to manage their debt profiles,” said Erik Falk, co-head of leveraged credit at KKR & Co.’s asset management unit, which oversees more than $13 billion of investments, including loans. “Issuers are willing to pay up, especially in this low-rate environment, on a spread basis.”
Spreads are widening to compensate for lending benchmarks that are at or near record lows.
Low Interest Rates
The Federal Reserve has kept the federal funds rate it charges to banks for overnight loans to an all-time low of zero to 0.25 percent since December 2008 to help stimulate lending. The three-month London interbank offered rate, which banks charge to lend to each other, yesterday was at 0.29 percent, and has been below 1 percent since May 2009.
Leveraged buyouts in the first nine months for this year rose to $86.3 billion from $39.3 billion during the same period in 2009, Bloomberg data show. Private-equity firms carried out $468.6 billion of buyouts by the end of the third quarter three years ago, at the height of the market.
Speculative-grade companies this year repaid $67.1 billion of loans maturing through 2014, reducing the amount of debt at the maturity wall’s peak to $353 billion, according to Bank of America Merrill Lynch data. Total leveraged loans outstanding were at $470.8 billion at the end of the second quarter, $100 billion less than 2008.
‘Unique Strength’
“The loan market has the wind at its back right now as cash flowing in via repayments creates a natural bid that suggests a unique strength,” said Dan Toscano, global co-head head of leveraged finance at Morgan Stanley. “Absolute yields and cost of capital are at historic lows, and yet credit spreads are still fairly wide.”
The margin over Libor for institutional loans rated two to three levels below investment grade increased to a record 4.14 percentage points since June, the widest since 3.89 percentage points in the last quarter of 2002, according to S&P LCD.
High-yield, high-risk debt is rated below Baa3 by Moody’s Investors Service and BBB- by S&P. So-called institutional loans are mainly bought by non-bank lenders such as collateralized loan obligations, mutual funds and hedge funds.
Due to a limited amount of transactions, there’s no spread data for new-issue institutional loans graded BB and BB- in the first and third quarters of 2009; figures for the final three months of 2008 through the first six months of last year aren’t available for B+ and B ratings, according to S&P LCD.
The Fed won’t raise its benchmark lending rate until the fourth quarter of next year, when the central bank might increase it to 0.5 percent, according to economist surveyed by Bloomberg News in September.
Monetary Easing
Fed officials on Sept. 21 reiterated a commitment to keep the federal funds rate at its historic low for an “extended period” when they also said that the central bank may ease monetary policy further to spur growth and support prices.
The world’s biggest economy grew at a 1.7 percent annual rate in the second quarter, the Commerce Department said yesterday, slowing from 3.7 percent in the first three months of the year and 5 percent at the end of 2009. Meanwhile, applications for U.S. unemployment benefits decreased by 16,000 to 453,000 last week, the Labor Department said, signaling that companies are cutting back firings even as the economic recovery slows.
“Markets are expected to remain in a sluggish-growth, low- inflation mindset and interest rates are likely to remain low for quite a while,” said Josh Feinman, global economist at DB Advisors, unit of Deutsche Bank AG that manages $217 billion of assets. “The modest recent improvement in data supports investor demand in risk assets.”
Loan Prices
The S&P/LSTA US Leveraged Loan 100 Index, which tracks the 100 largest dollar-denominated first-lien loans, gained 4.11 percent this quarter and is up 5.71 percent for the year.
Investor appetite for the debt resulted in 84 percent of loans raised this year to trade an average 0.87 cent above their issue prices, JPMorgan Chase & Co. analysts led by Peter Acciavatti said in a Sept. 24 report. All 27 loans sold in the last two months trade an average 1.33 cent over where they priced, according to the report.
Reynolds Group Holdings Ltd.’s $1.52 billion term loan D to help buy Pactiv Corp., Nalco Holding Co.’s $750 million of term loans to refinance debt, Advance Pierre Foods’ $1.065 billion of term loans for a three-way merger and Clopay Ames True Temper Holding Corp.’s $375 million loan backing a merger are among loans that rose after they started trading this week.
The loans had spreads ranging from 1.75 percentage point to 9.5 percentage points over Libor, with an average of 5.04 percentage points, Bloomberg data show.
Supply And Demand
Lenders got 1.5 percent to 1.75 percent floors on the lending benchmark for all but one of the loans to protect against historically low Libor levels. The companies issued the loans at a range of 95.5 cents to 99.5 cents on the dollar, reducing their proceeds and boosting the yield for investors.
“For now, supply is falling short of demand, so new vintage deals continue to trade well,” said Gil Tollinchi, senior vice president of credit trading at TCW Group Inc.’s leveraged finance unit, which has about $110 billion in assets under management. “There has been stability in older vintage deals, which have comparatively low spreads and no Libor floors.”
The $66.7 billion of leveraged loans issued since June is $4.44 billion less than the first three-month period this year and 60 percent of second-quarter volume, according to Bloomberg data.
Forward Calendar
As of Sept. 24, the amount of loans banks are planning to market to institutional investors had declined 19 percent from this year’s peak to $18 billion, the least since Aug. 27, according to weekly reports by strategists led by Bradley Rogoff at Barclays Capital, the investment banking arm of Barclays Plc.
“The forward calendar may be slowing down a bit, which will be effective in keeping the current rally alive,” said Richard Byrne, chief executive officer of Deutsche Bank Securities Inc., the investment banking unit of Deutsche Bank. “This year has been extraordinary and a lot of companies will continue to issue paper if demand remains strong.”
To contact the editor responsible for this story: Faris Khan at fkhan33@bloomberg.net.
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