Investors who purchase risky corporate loans are being squeezed by borrowers that are taking advantage of a supply shortage to cut rates on their existing debt, sending yields to their lowest in almost a year-and-a-half.
Yields have fallen to 4.6 percent from more than 6 percent at the beginning of 2015 as borrowers from PetSmart Inc. to the owner of Burger King and Tim Hortons reduced the interest they pay, according to data compiled by Bloomberg and Standard & Poor’s Capital IQ Leveraged Commentary & Data. Companies are seeking to cut rates on more than $29 billion of loans this month, the most since at least 2013, Bloomberg data show.
The trend is a byproduct of the slowdown in issuance that’s resulted from a regulatory push to curb risky underwriting on Wall Street. Loan sales have slumped to about a third of their pace in 2014, leaving investors little choice but to accept less compensation for the same level of risk.
“You wind up having your coupon and yield cut,” Bradley Rogoff, the New York-based head of global credit strategy at Barclays Plc, said in a phone interview. “If you’re an investor, you’re not happy with the lack of supply.”
The amount of the debt sold to money managers has plunged 66 percent to about $87 billion, Bloomberg data show.
At the same time, sales of collateralized loan obligations -- the biggest buyers in the market -- have boomed, further tipping the balance in favor of borrowers. More than $45 billion of CLOs have been created this year, following issuance of $123.7 billion in 2014, Bloomberg data show.
“Investors are reluctant to sell in this environment,” said John Fraser, managing partner at the U.S. debt arm of London private-equity firm 3i Group Plc. “It’s uncertain whether you’re going to be able to replace the sold asset.”
PetSmart, the Phoenix-based pet-store chain, lowered the rate by 0.75 percentage point on a $4.3 billion loan to 3.25 percentage points above lending benchmarks, extracting about $32 million in annual interest savings. The loan helped fund its March buyout by BC Partners.
Restaurant Brands International Inc., the owner of Tim Hortons and Burger King, last week lowered the rate on $5.14 billion of borrowings, while Community Health Systems Inc. refinanced $4.54 billion of loans that helped fund its takeover of Health Management Associates Inc. last year, Bloomberg data show.
“The mega-deals that we’re seeing are generally re-pricings, so it’s not new money,” Fraser said.
The debt’s dwindling compensation for risk has gotten the attention of Federal Reserve Chair Janet Yellen, who is surveying the financial landscape for indications of bubbles after more than six years of near-zero rates. She said this month in Washington that she sees signs of “reach for yield” behavior in the market.
The average spread on U.S. leveraged loans to money managers fell in April to 3.88 percentage points more than lending benchmarks, the lowest since February 2014, according to S&P Capital IQ LCD.
Prices in the secondary market have climbed in tandem. High-yield loan prices rose to an almost five-month high in late April to 96.7 cents on the dollar, and are up 1.2 percent this year, according to the S&P/LSTA U.S. Leveraged Loan 100 index.
“There are very few finds in the secondary market,” said Fraser. “It’s pretty picked over.”
Barclays expects demand to continue outstripping supply for loans. The $33 billion of known loan deals that banks are expected market to investors won’t be enough to satisfy demand as CLO issuance remains strong through the rest of the year, according to a May 15 report from Barclays.
“Investors should expect there’ll be limited new issue,” Rogoff said by phone. “The re-pricing wave will probably continue.”