For much of the past year, leveraged loan investors have been pushovers. Now, they’re showing signs of pushing back.
Money managers have demanded better terms on a spate of deals this week. Just today, Del Frisco Restaurant Group had to pay up when it borrowed a $310 million loan, agreeing to get just 95 cents from lenders for every dollar of debt it ultimately has to pay back, one of the steepest discounts seen this year. And underwriters have had to “flex,” or boost rates, on 15% of the leveraged loan deals they were syndicating to lure investors through Thursday, data compiled by Bloomberg show. That’s the worst since 2015, when oil prices were nosediving and credit markets broadly sold off as they braced for Fed tightening.
The market is still strong by many measures, but cracks may be developing in one of the best performing fixed-income markets in the U.S. this year. The pipeline of loans linked to acquisitions for syndication after the Sept. 3 Labor Day holiday is about twice the size of last year’s, with about $27 billion of loans teed up as of last week, so supply is likely to be strong.
Some money managers are waking up to the fact that credit risk is relatively high for all kinds of corporate debt now, said Mike Collins, senior investment officer at PGIM Fixed Income, which manages $717 billion. PGIM is an arm of Prudential Financial Inc.
“More speculative businesses are being financed in the loan market, high-yield bond market, and investment-grade market for that matter,” Collins said. “Markets are rightly pushing back on riskier transactions.”
With the Federal Reserve hiking rates, money managers have piled into investments like loans, which pay higher interest as central banks tighten, and into bundles of loans known as collateralized loan obligations. That demand has lifted the size of the U.S. leveraged loan market to around $1.3 trillion — now larger than the high-yield bond market — and spurred some companies to take out loans instead of selling bonds.
“Companies that really should be coming to the high-yield market and issuing at 6, 7, 8% yields are going to the loan market because the financing is much cheaper there,” Gershon Distenfeld, co-head of fixed income at AllianceBernstein LP, said on Bloomberg TV.
That trend may reverse as the Fed shows signs of being closer to the end of its rate hiking process, said Matt Toms, chief investment officer of fixed income at Voya Investment Management.
“There’s been a clear preference to buy floating-rate debt where investors can,” Toms said. “As we move into 2019, that’s less obvious an impulse.”
Amid the strong demand, money managers for much of the year agreed to weaker safeguards and protections on loans to junk-rated companies, Moody’s Investors Service said in a report last week. Around 80% of leveraged loans are “cov-lite,” meaning they lack meaningful protections against, for example, the company’s earnings falling to low levels. In 2006-2007, that proportion would have been less than 25 percent, the report said.