Avoca Builds Record Cash Hoard to Invest in Plummeting Junk Debt
Avoca Capital Holdings is planning to use a record cash hoard to buy high-yield debt that has plummeted 8.4 percent since July, the co-founder of the 6 billion-euro ($8 billion) fund said.
“We felt there will be better value later this year, especially in bonds, which haven’t fallen enough relative to loans,” Chief Executive Alan Burke said in an interview in London.
Avoca has 250 million euros set aside to buy junk bonds and leveraged loans, representing as much as 5 percent of the fund compared with less than 1 percent in the past. The firm, which manages 10 collateralized loan obligations, has also cut investment in junior-ranking debt to 4 percent from 12 percent a year ago and has no fixed-rate bonds at the moment.
Speculative-grade bonds in Europe have fallen to 89 percent of face value from 100.6 percent in July, according to a Bank of America Merrill Lynch credit index as Greece flirts with default and threatens to derail the economic recovery. European leveraged loan prices fell to a 2011 low of 87.1 percent of face value at the end of last week, according to Markit Group Ltd.
High-yield debt, or leveraged loans and junk bonds, are rated below Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s and Fitch Ratings. It finances buyouts.
‘A Lot of Money’
Burke is building up a cash arsenal as Blackstone Group LP’s head of restructuring Timothy Coleman said leveraged buyouts will resume when idle investors put cash to work. “There is a lot of money out there,” Coleman, 57, said yesterday at the Bloomberg Dealmakers Summit in New York.
Debt prices may drop further as policymakers’ efforts to revive a flagging economy fall short, according to Citigroup Inc. global head of credit strategy Matt King. The Federal Reserve’s decision to buy $400 billion of bonds maturing in six years or longer through “Operation Twist” may shave half a percentage point from 10-year government bond yields; it won’t persuade companies to hire and consumers to spend, King wrote in a Sept. 26 note to clients.
Loans are trading at a premium of about 6 percentage points to benchmark lending rates, implying a default rate of 30 percent. Avoca forecasts a default probability for the market of 3 percent.
“Loan prices are offering way too much yield relative to their default risk. The fair value would be somewhere between 300 to 400 basis points over Libor, or about mid-90s in price,” said Burke. “We don’t see value in bonds relative to loans at the moment but that could change in the next three to four months and we are ready for that when it happens.”
Burke left Allied Irish Banks Plc in July 2002 to start Avoca with Donal Daly. The Dublin-based manager has been “highly profitable,” according to Fitch, earning 17 percent annually for equity investors in its first CLO originated in 2003 and redeemed in December 2006.
The firm is looking to grow by purchasing assets from banks that need to reduce their 200 billion euros of loan portfolios to comply with new capital rules, Burke said. Loan prices may need to recover to 95 percent before banks put their inventories up for sale, he said.
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