Credit Strains Intensifying as Carlyle, Staples Meet Resistance

The riskiest parts of corporate debt markets are inching closer to panic mode.

Just ask Mark Heron, head of distressed debt at hedge fund Ellington Management Group. A dealer offered to sell him a loan at 97 cents on the dollar this week. Heron said he would buy it at 88 cents, a low-ball bid he thought would end the conversation. To his surprise, the dealer sold him the junk-rated loan at his price.

"You get the sense that there is a broader market issue," Heron said.

Widespread stress in high-yield bond and loan markets have walloped investors and are increasingly hurting companies looking to issue debt, particularly when acquisitions are involved. After investors resisted a $5.5 billion debt offering last year to fund Carlyle Group LP’s buyout of a Symantec Corp. unit, the two agreed on Tuesday to cut the price that the private equity firm would pay for the technology company’s data-storage unit Veritas.

Investors who agreed to lend money to fund Staples Inc’s $6.3 billion purchase of Office Depot Inc nine months ago are now trying to negotiate better terms on the financing, people with knowledge of the matter told Bloomberg.

"I suspect there are a lot of deals that were teed up, ready to come to the market, that will just have to stay on the shelf for the foreseeable future," said money manager Margie Patel, at Wells Capital Management in Boston, which manages about $350 billion. "The pipeline is going to dramatically shrink."

Worst Start

In the Staples deal, investors in the company’s loans are being asked to put money into escrow to fund an acquisition that was supposed to close by early February but now may take several months longer. The lenders said on a conference call Wednesday that they were reluctant to fund a loan on the same terms that they agreed to in April 2015, because junk bond markets have since cratered.

Investors are not only concerned about new debt issues. The cost of protecting an index of North American junk credits against default has suffered its worst start to a year since 2009, when the world was in the middle of a financial crisis. Exchange-traded funds that hold U.S. junk bonds slid to their lowest levels in almost seven years. An index of U.S. speculative-grade bonds has slumped 4.1 percent this month, almost equaling the 4.6 percent drop in all of 2015.

DoubleLine Capital has been cutting exposure to high-yield debt in its $5.3 billion core fixed income fund, bringing it down to 2.4 percent at the end of the year from 8.1 percent in May.

"The negative sentiment in the market has turned into a full-blown high yield selloff and more credits are going to run into trouble." said Kapil Singh, a money manager at DoubleLine. "High yield buyers are becoming choosier and choosier."

Rethinking Risk

Investors are reassessing their risk tolerance globally across multiple asset classes. This year, the Standard & Poor’s 500 index has fallen by about 8 percent, the MSCI world stock index has lost about than 10 percent and yields on 10-year U.S. Treasury notes slid below 2 percent on Wednesday. Oil futures declined to their lowest level since 2003 this week. 

The risk premium on the Markit CDX North American High Yield Index, a credit-default swaps benchmark tied to the debt of 100 junk-rated companies, surged as much as 113 basis points between Dec. 31 and Wednesday, reaching 583 basis points intraday, the highest level since 2012, and the biggest jump at the start of the year since 2009.

"A lot of funds limped into the new year hoping for a market rally but that just hasn’t happened," Heron said.

Slowing Growth

Investors’ concerns may be more than just shifts in sentiment-- there are signs that global economic growth is slowing and credit quality is getting weaker. Complacency about the risks of contagion from the weakest segments of high yield is reminiscent of sentiment regarding subprime debt in mid-2007, Heron’s firm wrote in a November report.

The International Monetary Fund said on Tuesday that it was cutting its forecasts for global economic growth for 2016 and 2017 by 0.17 percentage point, reflecting weaker growth in emerging economies.

That weaker growth has worried at least some central bankers. European Central Bank President Mario Draghi set the euro region up for expanded monetary stimulus for the third time in a year on Thursday, noting that there are "no limits" on how far the ECB will go to boost the economy as global risks escalate.

U.S. companies are generating less cash flow relative to their debt obligations, according to strategists’ estimates. The number of issuers whose ratings were cut to junk by Standard & Poor’s in 2015 rose to its highest in six years, the company said on Wednesday. More companies were at risk of having their credit ratings cut at the end of December than at the close of any other year since 2009, according to S&P.

With these headwinds, investors said that they hesitate to buy more junk bonds. 

"You can buy something at 8 percent and days later it’s trading at 10 percent,"said Mike Kirkpatrick, senior portfolio manager for high yield at Seix Investment Advisors. "There’s so much fear in the market."

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