America’s riskier credit markets suffered some deep wounds from a rocky start to the year.
The depth of the scars may not be obvious just by looking at returns. But under the surface, it’s clear the market has been damaged in terms of its main function -- providing financing to more-speculative companies.
A good example of this can be found in the $800 billion U.S. leveraged-loan market, which keeps riskier companies afloat and often finances leveraged buyouts. While companies managed to raise $36.1 billion in this market during the first three months of the year, most of the debt was tied to leveraged buyouts that were arranged before 2016, Barclays data show.
Going forward, the schedule of loan sales "has been a melting ice cube" as companies opt against leveraged buyouts or refinancing debt amid credit-market turmoil, Barclays analysts Bradley Rogoff and Eric Gross wrote in a report on Friday. This deteriorating sentiment is being exacerbated by the fact that the biggest buyers of this speculative-grade debt, collateralized loan obligations, are facing a squeeze.
The Barclays analysts lowered their prediction for the ceiling on new CLOs to $50 billion from $80 billion. The new expected total means that there may be less overall demand from these loan funds than the amount of money coming out of that market as old loans mature. Leveraged-loan mutual funds have continued to experience withdrawals, with investors pulling $5.5 billion from the funds so far this year, according to data compiled by Wells Fargo.
While demand for the debt may revive in the face of ongoing easy money policies, it would probably take a while for companies to arrange new loan sales, especially those tied to mergers and acquisitions. The implications are significant, starting with fewer leveraged buyouts. Companies may have a harder time refinancing debt. And loan prices may still remain low or go lower after falling to about 89 cents from 99.1 cents reached in 2014, even with muted supply.
The high-yield bond market is experiencing a similar phenomenon. U.S. junk-bond sales totaled $44.5 billion in the first three months, its weakest first quarter of issuance since 2009 and 54 percent lower than issuance in the period a year earlier, according to data compiled by Bloomberg. Meanwhile, the default rate is rising quickly, in large part because of increasing distress among energy, metals and mining companies.
While issuance has picked up a bit, yields are still relatively high at 8.6 percent compared with the record low of 5.7 percent reached in 2014, Bank of America Merrill Lynch index data show. That's just on average. It's becoming harder and more expensive for the riskiest companies to borrow.
Prices sometimes fluctuate without causing any serious or lasting repercussions, but this time is different. Even if junk-rated debt values recover, there have been some fundamental changes in the way corporate officers and investors rely on riskier bond and loan markets.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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