Investors are snapping up loans from low-rated companies, fueling a rally that is driving down borrowing costs for highly indebted companies.
Investors poured more than $8 billion into so-called leveraged loan funds in January and February, according to data from Refinitiv’s Lipper – the most in more than two years and a notable reversal from more than 26 billions of dollars in net outflows last year. That helped push loan prices to their highest levels since November 2018, beating yields on corporate bonds and Treasuries.
Companies issuing new loans, including web hosting company GoDaddy Inc.
and operator of Churchill Downs Racecourse Inc.,
benefit from demand, raising a record $110 billion in the first two months of the year. Other borrowers, such as consulting firm AlixPartners LLP and software company Kofax Inc., have pursued more opportunistic loan deals intended to pay a dividend to shareholders.
The rally is notable after loans rebounded from the pandemic more slowly than other assets last year. Now, with junk bond yields still hovering around 4.5% – below their pre-pandemic lows – investors are turning to leveraged loans as their payouts of interest increases with short-term rates.
Unlike junk bonds, leveraged loans are often also backed by a portion of the company’s assets, providing additional collateral.
The yield on the benchmark 10-year Treasury note recently rose above 1.6% to its highest level since the start of the pandemic, fueled by investor expectations of rebounds in growth and inflation fueled by vaccines and stimulus measures.
While more than $8.8 billion flowed into U.S. mutual funds and exchange-traded funds that buy loans in 2021, as of March 4, according to Refinitiv Lipper, investors were withdrawing $3.7 billion in funds of comparable junk bonds over the same period. Although junk bonds still offer a higher average yield, loans are larger in the capital structure, which puts investors closer to the front of the line to be paid in the event of bankruptcy. Loans are also often backed by a portion of the company’s assets, providing additional security.
“If you think inflation is coming or rates are going to go up, 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 have returned more than 1.8% in 2021, taking into account price changes and interest payments, ahead of the return of about 0.4% from high yield bonds and 10-year Treasury bills minus -5.2%. Loans rated triple-C, one of the lowest credit rungs before default, led the rally, returning more than 5.7% to investors over the same period.
Many investors view the lending market as a barometer of credit conditions, as deals tend to involve indebted companies with low credit ratings, a combination that tends to deter lending when people are worried about lending. ‘to come up.
One of the reasons the loan market has recovered more slowly than bonds is that the biggest buyers, who bundle loans into so-called secured loan bonds, have been caught up in the crisis. last year’s credit. Many large borrowers in the lending market were ineligible for Federal Reserve support and instead had to work with lenders to renegotiate or change loan terms.
CLOs are off to a flying start this year, with issuers selling more than $58 billion in the first two months of the year, according to data compiled by Barclays PLC, the biggest one-year start since at least 2013. Analysts expect CLO origination to grow from last year’s volumes, providing another stable 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 now offer investors reduced contractual protection against defaults and increased levels of debt to corporate earnings, which could hamper the ability of borrowers to repay their debts.
Loans generally do not prevent borrowers from repaying their debt sooner than expected, allowing them to take advantage of investor demand to refinance debt, which can limit investors’ returns. About 60% of the $110 billion in loans sold in January and February were used to refinance or reprice existing debt.
Loans securing a dividend payment to shareholders, often private equity firms, totaled $6.58 billion as of Feb. 9, the highest in a comparable period since 2017 and the second highest in data going back. to 2010.
As more retail money floods into the market, driving up prices, institutional investors are increasingly challenged to find loans with long-term potential, said David Moffitt, co-director of US credit management at Investcorp.
“Things seem to be priced perfectly,” he said.
Corrections & Amplifications
A chart that accompanied this article incorrectly quoted average leveraged loan prices in dollars instead of cents on the dollar. The graph has been updated. Additionally, a second reference to Refinitiv misspelled the name Refinitive. (Corrected March 15)
Write to Sebastian Pellejero at [email protected]
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