Late last week, we reported that in the aftermath of a dramatic drop in loan prices, a record outflow from loan funds, and a general collapse in investor sentiment that was euphoric as recently as the start of October, the wheels had come off the loan market which was on the verge of freezing after we got the first hung bridge loan in years, after Wells Fargo and Barclays took the rare step of keeping a $415 million leveraged loan on their books after failing to sell it to investors.
The two banks now "plan" to wait until January - i.e., hope that yield chasing desperation returns - to offload the loan they made to help finance Blackstone’s buyout of Ulterra Drilling Technologies, a company that makes bits for oil and gas drilling.
The reason the banks were stuck with hundreds of millions in unwanted paper is because they had agreed to finance the bridge loan whether or not there was enough demand from investors, as the acquisition needed to close by the end of the year. The delayed transaction means the banks will have to bear the risk of the price of the loans falling further, as well as costs associated with holding loans on their books.
The pulled Ulterra deal wasn't alone.
As we reported previously, in Europe the market appears to have already locked up, as three loans were scrapped over the last two weeks. To wit, movie theater chain Vue International withdrew a 833 million pound-equivalent ($1.07 billion) loan sale. While the deal was meant to mostly refinance existing debt, around 100 million pounds was underwritten to finance the company’s acquisition of German group CineStar.
More deals were pulled the prior week when diversified manufacturer Jason Inc. became at least the fourth issuer to scrap a U.S. leveraged loan. Additionally, Perimeter Solutions also pulled its repricing attempt, Ta Chen International scrapped a $250MM term loan set to finance the company’s purchase of a rolling mill, and Algoma Steel withdrew its $300m exit financing. Global University System in November also dropped its dollar repricing.
Today, the FT picks up on the fact that the junk bond market - whether in loans or bonds - has frozen up, and reported that US credit markets have "ground to a halt" with fund managers refusing to fund buyouts and investors shunning high-yield bond sales as rising interest rates and market volatility weigh on sentiment (ironically it is the rising rates that assure lower rates as financial conditions tighten and the Fed is forced to resume easing in the coming year, that has been a major hurdle to floating-rate loan demand as the same higher rates that pushed demand for paper to all time highs are set to reverse).
Meanwhile, things are even worse in the bond market, where not a single company has borrowed money through the $1.2tn US high-yield corporate bond market this month according to the FT. If that freeze continues until the end of the month, it would be the first month since November 2008 that not a single high-yield bond priced in the market, according to data providers Informa and Dealogic.
Separately, as we already reported, the FT notes that in the loan market at least two deals - including the Barclays/Wells bridge loan - were postponed and could be the first of several transactions pulled from the market this year, bankers and investors said, as mutual funds and managers of collateralised loan obligations — the largest buyer by far in the leveraged loan sector — wait out the uncertainty.
“This is clearly more than year-end jitters,” said Guy LeBas, a strategist at Janney Montgomery Scott. “What we’re seeing now is pretty typical for end-of-credit-cycle behaviour.”
A prolonged period of low interest rates since the financial crisis a decade ago has seen companies binge on cheap debt. However, as financial conditions have tightened, the high level of corporate leverage has raised widespread concern among regulators, analysts and investors.
In the loan market, it's not a total disaster just yet, because even as prices have slumped over the past two months, banks that committed to finance highly leveraged buyouts - including JPMorgan Chase and Goldman Sachs - have offered loans at substantial discounts to entice investors. As the chart below shows, the average new issue yield by month has exploded to the highest in years, with CCC-rated issuers forced to pay the most in 7 years to round up investor demand.
Still, as the following table from Bank of America shows, quite a few deals have priced, if only in the loan market:
Even so, other banks including Barclays, Deutsche Bank, UBS and Wells Fargo, have had to pull deals altogether as they just couldn't find enough buyers no matter how generous the concessions.
In addition to the Ulterra deal, technology services provider ConvergeOne postponed a $1.3bn leveraged loan offering that backed its takeover by private equity group CVC last week. As the FT notes, Deutsche Bank and UBS had marketed the deal to investors in a package that included senior and subordinated loans, with the junior debt expected to yield as much as 12 per cent in November when prices were first floated. While the banks attracted some bids for the debt, orders failed to surpass the overall size of the deal, which was postponed to the new year, according to people with knowledge of the transaction.
Why delaying deals into 2019? One word: hope.
One person familiar with the deal said the banks would market the loans again in January, when they hope market conditions will improve, and that other leveraged loans being marketed could be postponed to 2019.
The trouble lenders have faced in the leveraged loan market has mirrored the exasperation felt by investors in other asset classes. Higher-quality investment-grade bonds have also sold off, with a number of planned deals pulled from the market in recent weeks.
That said, for now the junk bond freeze and loan indigestion has remained confined to lower-rated issuers. However, that may change too, and should the "Ice-9" spread to the high-grade sector, where the bulk of issuance is to fund buybacks and M&A, that's when the real pain begins.