One week ago we noted that ominously the junk bond market appeared to have frozen without a single high yield bond pricing in the month of December, the first such occurrence since 2008. Yet while the bond market was on the verge of locking up especially in the lower rating tiers, we observed that the leveraged loan market was still functioning because even as prices had slumped over the past two months, banks that committed to finance highly leveraged buyouts offered loans at substantial discounts to entice investors. And, as the chart below shows, the average new issue yield by month had risen to the highest in years, with CCC-rated issuers forced to pay the most in 7 years to round up investor demand.
Even so, it was only a matter of time before the stock market contagion prompted a fearful reappraisal of the loan market, especially in light of the imminent collapse in CLO activity as a record amount of CLOs will be eligible to be reset or refinanced next month, putting even more pressure on prices...
... and the loan market itself froze up.
Sure enough, according to Bloomberg calculations, the ongoing rout in the corporate loans has now forced many of Wall Street’s largest banks to be stuck with at least $1.6 billion of unwanted leveraged buyout debt which they are unable to sell to investors in what is increasingly shaping up as a bidless market.
In addition to the previously discussed pulled loan deals by banks such as Barclays, Wells Fargo, and Goldman, virtually all banks that sell loans for LBOs are now struggling to sell loans they’ve agreed to make for private equity deals. As a result, at least four loan sales for buyouts and acquisitions have failed to clear the market so far this month, forcing the banks to keep the debt on their books, where it may incur mark-to-market risk should prices continue to fall, further depressing bank earnings. And, as discussed last night, the banks hope that by waiting until next year to sell the debt to investors the banks might be able to avoid a fire sale, however as further observed, deteriorating market dynamics could result in even further tightening in the market in early 2019.
The hung deals are equal to 14% of the $11.7 billion of loans sold in December, according to Bloomberg data. The good news is that they represent a small fraction of the more than $2.3 trillion of loans to corporations that were on U.S banks’ books as of Dec. 12, according to Federal Reserve data. The bad news is that as the fear and contagion spreads, the bidless market will hit more and more deals resulting in ongoing market lock ups, demands for even more price concessions, even higher yields until a feedback loops develops which may eventually culminate with a violent plunge in loan prices, which as shown below, have already suffered their worst drop in years.
Meanwhile, keep an eye on the following companies which are the proverbial canaries in the loan market coalmine - they were the first to see their loan deals pulled. They won't be the last.
- Ulterra Drilling Technologies: Blackstone’s acquisition of a majority stake in the drilling equipment supplier closed this month. Wells Fargo & Co. and Barclays had to keep a $415 million loan on their books and plan to offload it in January.
- Blue Racer: First Reserve’s acquisition of 50 percent of the pipeline operator is expected to close by the year end. The Goldman Sachs-led group arranging the financing ended up holding onto a $516 million loan. Goldman is now likely to sell the loan to a small group of buyers separate from the syndicated market, such as direct lenders or infrastructure funds, according to a person familiar with the matter. Barclays and Royal Bank of Canada are also involved.
- C&D Technologies: The firm’s acquisition of Trojan Battery closed on Thursday, without the Bank of America-led group of underwriters being able to offload the $400 million loan to finance the deal. Credit Suisse Group AG, ING Groep NV and KeyCorp are also involved.
- Apollo Infrastructure: Apollo Global Management LLC’s acquisition of a $1 billion investment portfolio from GE Capital’s Energy Financial Services is expected to close this quarter. Apollo Infrastructure has shelved the $275 million loan backing the deal, led by RBC. The loan is expected to return to the market in the new year once markets stabilize. BMO Financial Group and Goldman Sachs are also involved.