Unwanted loan rally cuts business borrowing costs
Investors are clawing back loans from low-rating companies, fueling a recovery that is lowering borrowing costs for heavily indebted companies.
Investors invested more than $ 8 billion in so-called leveraged loan funds in January and February, according to Refinitiv’s Lipper data – the most in more than two years and a notable reversal from more than $ 26 billion dollars in net outflows last year. This helped push loan prices up to around their highest levels since November 2018, beating yields on corporate bonds and Treasuries.
Companies that issue new loans, including web hosting company GoDaddy Inc.
and Churchill Downs Racecourse Operator Inc.,
are benefiting from demand, raising a record $ 110 billion in the first two months of the year. Other borrowers, such as consultancy firm AlixPartners LLP and software firm Kofax Inc., have entered into more opportunistic loan deals intended to pay dividends to shareholders.
The rally is notable after loans rebounded from the pandemic more slowly than other assets last year. Today, with junk bond yields still hovering around 4.5% – below their pre-pandemic all-time low – investors are turning to leveraged loans because of their interest payments. increase with short-term rates.
Unlike junk bonds, leveraged loans are often also backed against a portion of the company’s assets, providing additional collateral.
The benchmark 10-year T-bill yield recently climbed above 1.6% to its highest level since the start of the pandemic, fueled by investor expectations for rebounds in growth and the economy. inflation fueled by vaccines and stimulus measures.
As more than $ 8.8 billion poured into U.S. mutual and exchange-traded funds that buy loans in 2021, as of March 4, according to Refinitiv Lipper, investors were pulling $ 3.7 billion in funds from comparable scrap obligations over the same period. While junk bonds always pay a higher average return, loans are more prominent in the capital structure, bringing first-tier investors closer to being paid in bankruptcy. Loans are also often backed against a portion of the company’s assets, providing additional collateral.
“If you think inflation is coming or rates are going to rise, you’re going to want to move up the capital structure,” said Keith Berlin, director of global fixed income and credit at FEG Investment Advisors.
Loans returned over 1.8% in 2021, accounting for price changes and interest payments, before the yield of around 0.4% on high yield bonds and 10-year Treasuries minus-5.2%. Triple-C rated loans, one of the lowest credit ranks before default, led the rally, returning investors more than 5.7% over the same period.
Many investors view the loan market as a barometer of credit conditions, as transactions tend to involve companies with debt and low credit ratings – a combination that tends to discourage lending when people are worried. for the future.
One of the reasons the loan market has recovered more slowly than bonds is that the larger buyers, who bundle loans into so-called secured loan bonds, have been caught up by the credit crunch in the United States. last year. Many large borrowers in the loan market were ineligible for Federal Reserve support and had to work with lenders to renegotiate or change loan terms.
This year, CLOs are off to a hot start, with issuers selling more than $ 58 billion in the first two months of the year, according to data compiled by Barclays PLC, the biggest start to the year since at least 2013. Analysts expect CLO creation to grow over last year’s volumes, which is another constant source of loan demand.
Some companies have taken advantage of the recent recovery to reduce interest charges, which can lead to upgrades and higher loan prices. Some have improved the terms of their loans. This has raised concerns that leveraged loans also provide investors with reduced contractual protections against defaults and increased levels of debt relative to corporate earnings, which could hamper the ability of borrowers to repay their debts.
Loans generally do not prevent borrowers from paying off debts faster than expected, allowing them to take advantage of investor demand to refinance debt, which can limit investor returns. About 60% of the $ 110 billion in loans sold in January and February were used to refinance or revalue existing debt.
Loans guaranteeing the payment of dividends to shareholders, often private equity firms, totaled $ 6.58 billion as of February 9, the highest number in a comparable period since 2017 and the second highest total in data dating back to 2010.
As more and more retail money rushes into the market, driving up prices, institutional investors are finding it increasingly difficult to find loans with long-term potential, said David Moffitt, co-director of the US credit management at Investcorp.
“Things seem to be priced perfectly,” he said.
Corrections and amplifications
A chart that accompanied this article incorrectly showed average leveraged loan prices in dollars instead of cents per dollar. The chart has been updated. Additionally, a second reference to Refinitiv misspelled the name as Refinitive. (Corrected March 15)
Write to Sebastian Pellejero at [email protected]
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