For those of you who follow me this comes as no surprise. I have been highlighting the debt market issues for some time... Aivars Lode
Serious strains are starting to appear in the $1.2 trillion market for loans to high-risk companies, which have borrowed record sums in recent years as investors chased bigger yields.
The market, which survived the 2008 financial crisis, has become overstretched since then, say regulators and economists, who worry that it is now so big and risky its problems could amplify any economic damage caused by the coronavirus crisis.
“What I’ve always worried about is that the existence of overleveraged corporations will exacerbate a downturn that occurs for any reason,” said former Fed Chairwoman Janet Yellen in an interview.
Years of low interest rates and easy credit have allowed companies across the board to borrow big, building a record $10 trillion mountain of debt. Lenders expect the vast majority of that money to be repaid on time.
The epicenter of risk involves a subset of that total: $1.2 trillion in leveraged loans, junk-rated debt secured by corporate assets much like mortgages are backed by homes. The market has exploded, ballooning by almost 50%—or $400 billion—since the start of 2015, as investors desperate for the high interest payments these loans provided threw cash at borrowers.
The banks that make such loans rarely hold on to them now because of regulations passed after 2008. Instead they sell the debt directly to money managers or repackage it into complex securities that are marketed to investors around the world.
When prices of the loans drop, or they fall into default, the losses hit pensions, insurers, and scores of mutual funds and hedge funds, some of which react by selling out, exacerbating market swings.
In addition, investors become less willing to buy new loans and the banks that arrange such deals stop making new ones. That can be compounded by sharp losses in the complex securities Wall Street repackaged many of the loans into, causing credit markets to seize up and leave already indebted companies without access to fresh cash. The consequences could cascade: A wave of defaults and bankruptcies, forcing job cuts and amplifying the economic slowdown.
The impact will likely be long and drawn-out. Most loans don’t start coming due until 2022 and the hardest-hit sector—energy—is a small component of the market. Still, loan prices can fall sharply well before companies run out of cash, hurting investors who own the debt. And as business dries up for some companies, they may not be able to stay current on their existing loans.
Leveraged loans suffered their worst run since the financial crisis this month when a widely tracked index lost about 16% of its value. Prices for loans to 24 Hour Fitness Worldwide, which operates a chain of gyms, fell to about 44 cents on the dollar this week from 80 cents in February, according to analytics firm AdvantageData Inc. Prices of loans to airlines such as United Airlines Holdings Inc. and American Airlines Group Inc. declined about 10% in the first two weeks of March, more than any full-month loss since October 2008, according to S&P Dow Jones Indices.
Repackaging loans into bundles called “collateralized loan obligations” became popular in the 2000s, alongside similar techniques employed to market mortgage-backed bonds. Unlike mortgage bonds, very few CLOs defaulted in the 2008 financial crisis. That record and their high yields have made CLOs popular in recent years, but they are susceptible to violent price swings and have been one of the worst-performing debt investments this month.
Loan investors remain hopeful that the virus will subside and that its aftershocks will be brief. But with the amount of loans outstanding about twice as large as in 2008, according to data from S&P Global, a recession will likely trigger a larger wave of defaults and heavier losses on their debt than the dot-com bubble or the financial crisis, analysts say.
Companies that borrow in the junk loan market now are far weaker financially than those in that era. Borrowers with loans Moody’s Investors Service rated at the lowest rungs of the junk-debt ladder—B3 or lower—made up 38% of the market in July compared with 22% in 2008.
“Investors will probably be surprised by the extent of their losses on loans compared with their historical losses,” said Oleg Melentyev, a strategist at Bank of America Corp. He calculates that about 29% of outstanding leveraged loans will likely default cumulatively in the next credit downturn, compared with an average of about 20% by junk-rated companies during the 2007 to 2009 period. Worse yet, investors will likely recover less money: about half of their original investment, compared with 58% back then.
The storm is rocking even well-established leveraged-loan borrowers like hotel chain Hilton Worldwide Holdings Inc. The company took out a $2.6 billion loan in June to refinance debt left over from when Blackstone Group bought it over a decade ago, according to data from LevFin Insights.
Prices for the loan, stable at 100 cents on the dollar in late February, have now fallen to about 83 cents on the dollar, according to data from IHS Markit. The company has borrowed more in recent days on a $1.75 billion revolving loan—basically a line of credit—to build cash as tourism and travel plummet. Prices of the revolver have fallen to around 79 cents.
No comments:
Post a Comment