The market for loans to below-investment grade companies is off to its slowest start in five years as regulators step up efforts to curb risky underwriting and investors put their money elsewhere.
About $63 billion of leveraged loans have been sold to money managers this year, down 69 percent from 2014 and the least since $53 billion was issued during the same period in 2010, according to data compiled by Bloomberg. Investors have pulled a net $5.5 billion this year from funds that buy the debt, adding to last year’s record $23.9 billion in withdrawals and further denting demand for debt that’s backing acquisitions of companies from PetSmart Inc. to Office Depot Inc.
The loan market is mired in a slump that started a year ago as regulators led by the Federal Reserve increased scrutiny on what they deemed excessive risk-taking by Wall Street’s biggest lenders. That’s prompted some banks to shun deals that don’t meet the Fed’s underwriting guidelines, at the same time that fund outflows have helped push up borrowing costs, slowing refinancing activity.
“The leveraged-lending guidelines have really started to bite,” said Jonathan Insull, a New York-based money manager at Crescent Capital Group, which oversees about $16 billion of speculative-grade debt. Treasurers have been turning to the junk-bond market, where appetite for speculative-grade debt has returned even as loan-fund outflows persist, he said.
U.S. high-yield bond funds have attracted $10.5 billion in net inflows this year, according to Lipper data. The $99.7 billion of junk bonds issued in the U.S. this year is up 27 percent from the same period last year, Bloomberg data show.
Banks are steering away from leveraged buyouts that load up a company with debt levels deemed too risky in lending guidelines updated by regulators in March 2013. Total debt used to fund large LBOs was on average 5.6 times a measure of earnings last quarter, down from as high as 6.3 times in the three months through September, according to Standard & Poor’s Capital IQ Leveraged Commentary & Data.
“The leveraged lending guidelines actually have teeth,” said Mark Okada,chief investment officer at Dallas-based Highland Capital Management, which invests in high-yield credit. “They’re taking a bite out of the calendar.”
New guidelines indicate that a debt level of more than six times a measure of earnings raises concern and say that borrowers should be able to repay debt within a reasonable period.
Elevated stock prices are also hampering demand for the debt because they’re making it more expensive for buyout firms to take companies private, said Insull.
Deals backing mergers and acquisitions have been “sporadic,” Tim Broadbent, the New York-based head of Americas leveraged loan syndicate at Barclays Plc, said in a phone interview. “It hasn’t been as strong as we all like it.”
One of the larger anticipated deals will help finance Staples Inc.’s $6.3 billion acquisition of Office Depot. A meeting with lenders is scheduled on Tuesday to discuss a $2.75 billion term loan that’ll help pay for the purchase, according to a person with knowledge of the financing, who asked not to be identified because the talks are private.
S&P said Monday it expects to lower Staples’s credit rating to one level below investment grade because the Framingham, Mass.-based office supplier plans to add about $4.3 billion of new debt, more than doubling leverage to 3.4 times a measure of earnings, according to the statement.
PetSmart, rated four levels beneath investment-grade by S&P, attracted buyers to a $4.3 billion loan backing its $8.7 billion buyout by BC Partners even as some were concerned that it may not meet lending guidance. Moody’s Investors Service estimated in February the buyout financing would push PetSmart’s debt to as high as 7.25 times.
Acquisition financing made up 71 percent of first-quarter volume in the loan market, followed by 22 percent for refinancing, according to an April 1 research report from JPMorgan Chase & Co.
U.S. leveraged loans were sold to investors at an average 4.1 percentage points more than lending benchmarks as of March 26, data from S&P’s Capital IQ LCD show. Spreads have been wider than 4 percentage points in all but one month since last April.
Many companies are holding back from issuing loans to refinance debt as the cost of borrowing has been relatively high for the past year, Broadbent said.