High-Yield, High-Risk Loans in Demand

Leveraged loan volume through July 2013 is already greater than the total for all of 2012—and is on track to pass the record set in 2007.

The riskiest U.S. companies are stepping up their borrowing in the market for leveraged loans, with the amount of financings completed this year already exceeding what they raised in all of 2012.

Borrowers from HJ Heinz Co. to Valeant Pharmaceuticals International Inc. have tapped non-bank lenders for $298.4 billion in 2013, more than the $295.3 billion obtained last year, according to Standard & Poor’s Capital IQ Leveraged Commentary and Data. At the current pace, the record of $386.6 billion set in 2007 will be eclipsed before year-end.

Rather than leveraging up, more than half of the loans made this year have been used to reduce interest costs or extend maturities, as companies take advantage of investor demand to strengthen their balance sheets. Investors added a record $2.1 billion last week into funds that buy loans, bringing the total for the year to more than $40 billion, according to Bank of America Corp.

“We have seen significant demand” for high-yield, high-risk loans, said Scott Baskind, the co-chief investment officer for the senior secured bank loan team in New York at Invesco Ltd., which oversees $22 billion of the debt.

More loans that aren’t tied to refinancings may be completed by year-end as merger and acquisition activity heats up, Baskind said, following a 17 percent drop in the number of leveraged buyouts from the same period of 2012.

Loans have generated a return of 3.2 percent this year, according to the S&P/LSTA U.S. Leveraged Loan 100 Index. That compares with gains of 3.04 percent on the Bloomberg High Yield Index.

The average interest margin rose to 4.45 percentage points more than benchmark rates in June from 3.7 percentage points in May amid concern the Federal Reserve may begin to pull back from its unprecedented stimulus. The gap shrank to 4.1 percentage points last month as those concerns eased, according to S&P LCD.

Elsewhere in credit markets, BMC Software Inc. is planning to sell $1.38 billion of notes denominated in dollars and euros to help fund its purchase by a group led by Bain Capital LLC and Golden Gate Capital. Wall Street banks are offering commercial- mortgage bonds at relative yields that are lower than on deals issued earlier last month, aiding lenders with $5 billion of transactions to sell. New York’s Metropolitan Transportation Authority obtained $200 million of protection with bonds designed to guard against wreckage linked to storm surges.

 

Swap Spreads

The U.S. two-year interest-rate swap spread, a measure of debt market stress, increased 0.3 basis point to 16.7 basis points. The gauge widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.

The cost of protecting corporate bonds from default fell. The Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, decreased one basis point to a mid-price of 74.6 basis points, according to prices compiled by Bloomberg.

The Markit iTraxx Europe Index of credit-default swaps tied to 125 companies with investment-grade ratings fell 2.7 to 97.2 at 10:48 a.m. in London. In the Asia-Pacific region, the Markit iTraxx Asia index of 40 investment-grade borrowers outside Japan decreased 3.1 to 143.4.

The indexes typically fall as investor confidence improves and rise as it deteriorates. Credit-default 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.

Bonds of JPMorgan Chase & Co. were the most actively traded dollar-denominated corporate securities by dealers, accounting for 2.7 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

BMC is marketing $1.05 billion of securities and 250 million euros ($332.5 million) of debentures and may price the debt next week, according to a person with knowledge of the transaction. The information technology provider announced the $6.9 billion buyout, which also includes investors GIC Special Investments Pte Ltd. and Insight Venture Partners, on May 6 after abandoning a sale last year. Proceeds will be placed in escrow until the acquisition is completed, the Houston-based company said in a statement.

Property Debt

Top-ranked 10-year securities linked to U.S. properties are being marketed by JPMorgan and Barclays Plc to yield as much as 108 basis points more than the benchmark swap rate, a person with knowledge of the transaction said. Goldman Sachs Group Inc. and Citigroup Inc. sold similar notes on July 18 at a spread of 113 basis points.

Dealers have arranged about $45 billion in commercial-mortgage bonds this year, according to data compiled by Bloomberg. Sales are poised to double from 2012 to $70 billion by year-end, according to Credit Suisse Group AG.

New York City’s subway operator is paying less than the cost of traditional property coverage by buying protection from MetroCat Re Ltd., a Bermuda-based special-purpose insurer that issued the three-year securities, the MTA said in a statement. The bonds yield 4.5 percentage points more than three-month Treasury bills, Bloomberg data show.

In emerging markets, relative yields widened 4 basis points to 340 basis points, or 3.4 percentage points, according to JPMorgan’s EMBI Global index. The measure has averaged 298.7 basis points this year.

 

Loan Prices

The S&P/LSTA U.S. Leveraged Loan 100 Index fell 0.01 cent to 98.24 cents on the dollar. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, has declined from 98.4 cents on July 23, the highest since May 30.

Leveraged loans and high-yield bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at S&P.

Investors have been pouring money into mutual funds that buy loans as a hedge against a possible rise in rates.

Mutual funds purchased 33 percent of loans sold to non-bank lenders during the second quarter, up from 21 percent in the first quarter, according to S&P LCD. Collateralized loan obligations (CLOs) remain the largest buyers of the debt, with a 53 percent share, down from 60 percent during the first quarter.

Money managers have raised $52 billion of CLOs this year globally, compared with $55.7 billion in all of 2012, according to a July 26 JPMorgan report. CLOs are a type of collateralized debt obligation that pool high-yield, high-risk loans and slice them into securities of varying risk and returns.

Speculative-grade borrowers obtained $157 billion of loans to refinance debt this year, while reducing the rate on $187.7 billion of existing loans, according to S&P LCD.

“You saw a pretty heavy repricing calendar in the first quarter and early second quarter of this year,” John Cokinos, the head of leveraged finance capital markets and syndicate at Bank of America in New York, said in a telephone interview.

Borrowers typically take advantage of a slowdown in merger activity and a rise in loan prices to seek a rate cut on their loans, according to Cokinos.

Heinz obtained about $12 billion in loans backing the ketchup makers acquisition by Warren Buffett’s Berkshire Hathaway Inc. and 3G Capital, Bloomberg data show.

Valeant got a $3.55 billion term deal as part of a transaction financing its purchase of Bausch & Lomb Holdings Inc.

Default Rates

The 12-month trailing global speculative-grade default rate fell to 2.8 percent at the end of the second quarter, from 3.1 percent in the same period last year, Moody’s said July 11. The ratings firm expects the rate to rise to 3.2 percent by year-end, before falling to 2.7 percent by the end of the second quarter of 2014.

Institutional loan issuance fell from $49.3 billion in May to $28.2 billion in June after Fed Chairman Ben S. Bernanke indicated in testimony to lawmakers that the central bank may reduce the $85 billion it spends every month buying Treasuries and mortgage bonds. The central bank pledged to keep buying the bonds yesterday, the Federal Open Market Committee said after a two-day meeting in Washington.

The initial Fed statement “had a significant impact,” and “we saw a global pullback in fixed income, emerging markets, investment grade, and high yield, and that caused a broad correction in the market,” Invesco’s Baskind said.

 

Junk Outflows

High-yield bond funds, which had been buying loans, saw outflows of $12.6 billion in May and June, according to data from Morningstar Inc. That led some investors to sell their loan holdings, said Joe Moroney, a senior money manager who helps run the senior credit business at Apollo Global Management LLC in New York.

While loan issuance slowed in June and July, a recent pickup in merger activity may mean new debt financings in coming months. Merger and acquisition volume rose to $111 billion in July, an increase from $71 billion in June, according to a July 30 Bank of America report.

Hudson’s Bay Co., Canada’s biggest department store operator, has obtained $2.8 billion of debt financing commitments to back its acquisition of Saks Inc., according to a July 30 regulatory filing. Community Health Systems Inc., the second-largest U.S. hospital chain, obtained $6.8 billion in loan commitments backing its purchase of Health Management Associates.

“There is some larger M&A activity coming that is going to provide some good opportunity in terms of sizable transactions,” Baskind said.

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