Loan Surge Above Par Putting Investors at Risk: Credit Markets
More speculative-grade U.S. loans are trading above par than at any time since May, exposing investors who are funneling record amounts of cash into the debt to greater risks as rising prices encourage borrowers to refinance at lower interest rates.
Spanish-language broadcaster Univision Communications Inc. and KKR & Co.-controlled First Data Corp. are among at least 30 companies seeking to reduce rates on $31 billion of bank debt as more than 80 percent of leveraged-loan prices exceed 100 cents on the dollar, according to JPMorgan Chase & Co. That’s up from 40 percent at the beginning of October, according to a report from the New York-based lender last week.
“Loans are trading well above their call prices because the investor community is reaching out for existing loans,” Jonathan Kitei, head of U.S. loan distribution at Barclays Plc in New York, said in a telephone interview. “You will see more loans getting repriced.”
Investors last year deposited about $63 billion into loan funds that invest in debt with rates that rise with benchmarks and have limited restrictions on early repayment. Banks from Barclays Plc to JPMorgan and Citigroup Inc. expect loans to underperform compared with 2013 as the Federal Reserve begins to taper its bond purchases, paving the way for an increase in rates that have been kept near zero for the last five years.
“Whenever loans are trading above par, you introduce an additional risk element as there is limited call protection,” David Breazzano, president of DDJ Capital Management LLC, which manages more than $7 billion in high yield assets, said in a telephone interview. “Value in loans has dissipated a bit in the last couple of months.”
Companies reduced borrowing costs on $281 billion of speculative-grade loans last year, or almost 4 times more than 2012, according to Standard & Poor’s Capital IQ Leveraged Commentary and Data.
Chrysler Group LLC (CGC) cut annual interest expense by as much as $72 million, tapping investor demand to reduce interest rates on its borrowings, according to data compiled by Bloomberg.
The automaker controlled by Italy’s Fiat SpA, which was paying 4.75 percentage points more than the London interbank offered rate, with a 1.25 percent minimum on the lending benchmark on a $2.93 billion loan, cut the rate on the debt twice last year. Chrysler reduced its interest on the debt to 2.75 percentage points more than Libor, with a 0.75 percent floor.
Investors have added $2.4 billion to loan mutual funds this year, according to Bank of America Corp. The funds have been able to garner interest for the asset class, highlighting the floating-rate debt’s seniority in the capital structure and room for increased income with rising interest rates as the debt is pegged to floating-rate benchmarks.
The average price on the floating-rate debt climbed to 98.67 cents on the dollar on Jan. 17, the most since July 2007, according to the S&P/LSTA U.S. Leveraged Loan Index .
The average yield on leveraged loans issued by U.S. companies last month was 5.1 percent, down from 6.4 percent at the same time in 2012, according to S&P LCD.
Leveraged loans and high-yield, high-risk bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at S&P.
JPMorgan, the second-largest underwriter of the debt in 2013, forecasts 4.5 percent gains for loans this year, compared with 5.3 percent in 2013.
Bank of America, the largest underwriter expects returns to slow to 4 percent, while Barclays sees 3.5 percent to 4.5 percent. The debt has gained 0.4 percent this month, S&P/LSTA index data show.
The last time, when so many loans were trading above par was in May, according to Barclays. The price on the S&P/LSTA index, which climbed to 98.62 cents on the dollar on May 22, fell to a low of 97.31 cents on July 5 before recovering.
The U.S. central bank is trimming its monthly asset purchases by $10 billion, the Federal Open Market Committee said Dec. 18. The Fed will probably reduce its bond buying in $10 billion increments over the next seven meetings before ending the program in December 2014, according to economists surveyed by Bloomberg in December.
Investors have sought to shield themselves from rate reductions by seeking call protection. Almost all of the new loans being issued last year had such restrictions place on borrowers from replacing or refinancing credit pacts, up from about 40 percent four years ago, according to Barclays.
“Everybody is demanding call protection but it’s almost useless,” Alex Jackson, the head of the bank loan group at Cutwater Asset Management in Armonk, New York, said in a telephone interview. “It’s only good for two quarters.”
First Data is seeking to reduce the rate on a $2.49 billion term loan, according to a person with knowledge of the transaction. The company is looking to lower rates by as much as 0.75 percentage points, said the person, who asked not to be identified without authorization to speak publicly.
Univision more than doubled the size of bank debt on which it’s seeking to lower rates to $3.37 billion from $1.5 billion it initially proposed, while seeking to shave 0.5 percentage points in interest cost, data compiled by Bloomberg show.
“You’ve got persistent inflow into mutual funds,” Cutwater’s Jackson said. “If you don’t have supply of new issue, existing loans are bid up. You have to be worried about buying stuff and having it called.”
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, a credit-default swaps benchmark used to hedge against losses or to speculate on creditworthiness, climbed 0.8 basis point to a mid-price of 66.15 basis points at 11:05 a.m. in New York, according to prices compiled by Bloomberg.
The Markit iTraxx Europe Index of 125 companies with investment-grade ratings increased 0.35 to 71.9.
The indexes typically rise as investor confidence deteriorates and fall as it improves. 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 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 fell 0.25 basis point to 13.5 basis points. The gauge typically widens when investors seek the perceived safety of government debt and narrows when they favor assets such as corporate bonds.
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