Leveraged loan sales are approaching a three-year high, enabling companies to slash borrowing costs, as yields relative to junk bonds reach the narrowest in 10 months.
Speculative-grade firms raised $260.1 billion in loans this year, more than double the amount in the same period of 2009, according to data compiled by Bloomberg. Reynolds Group Holdings Inc. and Tomkins Plc boosted loans in the past month at the expense of secured high-yield bonds.
The average yield on junk bonds is 80 basis points, or 0.8 percentage point more than leveraged loans, about the narrowest gap since December and down from 165 in April. Sales of secured bonds have dropped to 28 percent of speculative-grade issuance from 41 percent last year as default rates plummet amid signs the economy isn’t slipping back into recession.
“The loan market is reactivating, removing the need for some of these companies to sell secured paper since they’re finding more demand for loans at a cheaper rate,” said Kingman Penniman, president of high-yield research firm KDP Investment Advisors Inc. in Montpelier, Vermont. “Investors are getting more comfortable with some of these credits so they’re willing to move down and get paid for it.”
The U.S. speculative-grade default rate dropped to 4 percent at the end of the third quarter, from 6.4 percent in the three-months ended in June and 14.2 percent a year earlier, Moody’s Investors Service said in an Oct. 6 report. Moody’s forecasts the rate will fall to 2.8 percent by December.
High-yield, high-risk debt is rated below Baa3 by Moody’s and lower than BBB- by Standard & Poor’s.
The U.S. economy expanded at an annual pace of 1.85 percent in the third quarter and will grow at a rate of 2.3 percent in the last three months of the year, according to 64 economists surveyed by Bloomberg News. The economy expanded 1.7 percent from April through June.
Elsewhere in credit markets, the extra yield investors demand to own company bonds instead of similar maturity government debt was unchanged at 169 basis points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. That’s the narrowest since May 13 and down 12 basis points since Aug. 31. Average yields fell to 3.36 percent from 3.37 percent on Oct. 8.
A benchmark indicator of corporate credit risk in the U.S. climbed for the first time in a week. Credit-default swaps on the Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, increased 0.54 basis point to a mid-price of 97.04 basis points as of 12:30 p.m. in New York, according to index administrator Markit Group Ltd.
Swedish Export Credit
The index, which typically rises as investor confidence deteriorates and falls as it improves, touched the lowest in more than five months yesterday at 96.5 basis points.
Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point, 0.01 percentage point, equals $1,000 annually on a contract protecting $10 million of debt.
Swedish Export Credit, the Stockholm-based, government- owned lender, plans to sell $1 billion of five-year global notes denominated in U.S. dollars, according to a person familiar with the offering. The bonds may be sold as soon as tomorrow, said the person, who declined to be identified because terms aren’t set. The debt may yield about 40 basis points more than the midswaps rate, the person said.
Junk bond yields have been declining from a monthly peak in November 2008 of 21.7 percent, and fell to 7.85 percent yesterday, the lowest since before the credit crisis, according to Bank of America Merrill Lynch’s US High Yield Master II Index.
Yields on leveraged loans reached 27.28 percent in December 2008, data compiled by JPMorgan and S&P’s Leveraged Commentary and Data unit show. Loan yields were 774 basis points higher than bonds that month. The relationship reversed in August 2009.
Banks arranged in 2007 a record $878 billion of leveraged loans, which are typically senior to all debt in a company’s capital structure, meaning they must be repaid in full before the claims of bondholders.
Reynolds, owned by New Zealand’s richest man, Graeme Hart, cut its secured bond offering by $500 million and boosted a term loan by the same amount for its $6 billion acquisition of Lake Forest, Illinois-based Pactiv Corp..
The Auckland-based company’s 7.125 percent notes due 2019 rose to 102.625 cents to yield 6.59 percent on Oct. 8, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Reynolds’s $1.52 billion term loan issued at 99 cents on the dollar to yield about 6.6 percent climbed to 100.5 cents when it first traded Sept. 28, Bloomberg data show.
Canada Pension Plan Investment Board and Onex Corp. scrapped a $600 million portion of a secured bond sale and reduced a revolving credit line by $100 million in financing their takeover of London-based auto-parts maker Tomkins. They added the aggregate amount to a term loan that grew 70 percent in size to $1.7 billion.
Tomkins issued the debt at 99 cents on the dollar to yield about 6.4 percent and the loan jumped 1.75 cents after it began trading on Sept. 21, according to Bloomberg data. The company’s $1.15 billion of 9 percent secured notes due 2018 sold on Sept. 21 traded at 104 cents to yield 8.14 percent, according to Trace.
Speculative-grade companies sold $57.9 billion of secured notes in 2010, compared with $67.1 billion last year, the most since at least 1999, Bloomberg data show. Sales of the debt made up 19 percent of junk offerings in September and 25 percent this month, compared with an average of 28 percent for the year.
“The problem with having security on bonds is that you can be tied up for 7 to 10 years with that kind of structure,” said Eric Peiffer, managing director in Cleveland at KeyBanc Capital Markets, which has helped manage high-yield bond offerings by 25 companies this year. “It prevents you in the future if you run into financial distress from inserting debt between yourself and secured credit facilities.”