Junk-rated companies agreed to boost interest rates on more U.S. loans than any time since at least 2011, as lenders extracted more compensation with prices of the floating-rate debt tumbling from a six-year high.
Drug distributor Valeant Pharmaceuticals International Inc. (VRX) to toothbrush-maker Water Pik Inc. were among companies that sweetened terms on $17.7 billion of loans in June, accounting for 43 percent of total deals, according to Standard & Poor’s Capital IQ Leveraged Commentary & Data. That’s 10 times greater than in May and the highest in data going back to January 2011. Twenty issuers failed to get loan financing, versus 22 for the first five months of the year, as the average price of the senior-ranking debt fell by the most since May 2012.
Investors are demanding more in interest to fund the $550 billion market for leveraged loans after Federal Reserve Chairman Ben S. Bernanke indicated the central bank could slow the pace of its stimulus if economic growth keeps pace with its forecasts. The comments triggered a surge in debt yields, causing a drop in loan prices as high-yield fund managers dumped the debt to mitigate losses on junk bonds.
“With the drop in loan prices, new issuers have had to do more to make their debt look attractive,” Frank Ossino, a Hartford, Connecticut-based money manager who oversees about $2.5 billion of leveraged loans at Newfleet Asset Management, said in a telephone interview. “The ability for lenders to push back has been largely created by the weakness in the high-yield bond market.”
Loan prices, which had climbed to a six-year high on May 22, declined 0.89 cent to 97.33 cents on the dollar in June, the biggest monthly decline in more than a year, according to the Standard & Poor’s/LSTA Leveraged Loan Index.
The Fed chairman’s statements at the end of a Federal Open Market Committee meeting on June 19 stoked speculation the central bank will soon begin to scale back efforts that have pumped more than $2.5 trillion into the financial system since 2008. That sparked the three biggest weekly outflows from high-yield bond funds.
For the week ended June 26, investors pulled $3.1 billion from U.S. junk-bond funds, putting the month on track to set a new record of about $16 billion of outflows, according to a June 27 report from Bank of America Corp. (BAC) Loans, which have rates that fluctuate and offer defense against higher borrowing costs, held up better and gained $5 billion.
“The loan market isn’t driven directly by Bernanke’s comments,” Eric Meyer, a money manager at Deutsche Asset and Wealth Management, where he oversees about $4 billion in U.S. loans, said in a telephone interview. “If those comments make people nervous about credit markets in general, loans will see an impact, even if it is to a lesser extent.”
Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. rose. The Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, increased 0.19 basis point to a mid-price of 84.6 basis points as of 11:22 a.m. in New York, according to prices compiled by Bloomberg.
The index typically rises as investor confidence deteriorates and falls as it improves. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
The U.S. two-year interest-rate swap spread, a measure of debt market stress, increased 0.25 basis point to 16.6 basis points as of 11:22 a.m. in New York. The gauge widens when investors seek the perceived safety of government securities and narrows when they favor assets such as company debentures.
Bonds of Goldman Sachs Group Inc. (GS) are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 3.8 percent of the volume of dealer trades of $1 million or more as of 11:23 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Junk bonds lost 3.1 percent in June, cutting gains this year to 1.1 percent, according to the Bloomberg USD High Yield Corporate Bond Index. (BUHY) Leveraged loans shed 0.6 percent during the same time period in the first monthly loss since May 2012, S&P/LSTA data show.
Leveraged loans and junk bonds are high-yield, high-risk debt rated below Baa3 by Moody’s Investors Service and lower than BBB- by S&P.
High-yield funds had increased holdings of loans to 8.3 percent in December, from 7.5 percent six months earlier, according to a review of select funds by S&P LCD. Since 2010, the senior-ranking debt in such funds doubled to $24 billion of the $293 billion in total assets, according to an S&P/LCD estimate.
The fund managers discarded loans to meet redemptions in a bid to limit losses, Newfleet’s Ossino said.
As high-yield managers sell loans “it put pressure on loan prices and in turn loan yields,” he said. “This in effect results in the market repricing itself.”
The spread on loans sold to non-bank lenders averaged 4.29 percentage points more than benchmark rates in June, according to S&P/LCD. That’s up from 3.7 percentage points in May, which was the lowest since November 2007.
Less than 50 percent of outstanding loans are trading above par, according to data compiled by Barclays. That compares with figures in excess of 80 percent two months ago, according to a May 3 report from the bank.
Term-loan issuance dropped to the slowest pace this year, with about $35 billion of floating-rate debt syndicated last month, bringing issuance this year to about $445 billion, Bloomberg data show.
Beats Electronics LLC, the headphone maker founded by music producer Jimmy Iovine and rapper Dr. Dre, withdrew plans June 24 to borrow as much as $650 million in loans due to market conditions.
Proceeds of the loan would have been used to refinance $225 million of maturing debt and for additional purposes, including distributions to shareholders.
Carl Icahn-controlled auto-parts supplier Federal-Mogul Corp. canceled plans to refinance $3.05 billion of debt. The company was seeking a $1.75 billion term loan, a $550 million revolving credit line and $750 million of bonds, according to a June 10 regulatory filing.
“Expectations had been set by bankers based on how the first few months of the year had gone,” Trey Parker, head of credit research at Highland Capital Management LP, which manages about $14.5 billion in leveraged-loans, said in a telephone interview. “When the high-yield guys pulled back, it softened the excess demand.”
Valeant increased the rate on a $3.55 billion loan backing its purchase of Bausch & Lomb Holdings Inc. The Canadian drug distributor is offering the term loan at 3.75 percentage points more than the London interbank offered rate, with a 0.75 percent minimum on the lending benchmark, according to a person with knowledge of the deal who asked not to be identified because the terms aren’t set.
That compares with a margin of 3.25 percentage points to 3.5 percentage points proposed earlier, with the same Libor floor. The loan will be offered to lenders at 98.5 cents on the dollar, compared with 99.5 cents previously.
Water Pik increased the rate on bank debt backing its leveraged buyout by MidOcean Partners LP. The margin on a $215 million term loan widened to 4.75 percentage points more than Libor from 4 percentage points more than the benchmark, Bloomberg data show.
“When borrowers really need the money, and there’s market volatility, that’s when lenders strike the better-structured and good-paying deal,” Ossino said. “It’s when the markets are hot, that transaction terms loosen and yields tighten.”
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