This is not a bad one-time transaction. Borrowers and investors are seeing a sharp rise in interest costs and slashed prices in the market for risky and poorly rated loans. Soaring inflation and fears of potential recessions ravaging stocks, bonds, currencies and crypto are also hurting lending. This is a problem for banks that take out loans and resell them to investment funds. The average discount on loans sold over the past month is the highest in a decade with prices averaging 95.5 cents on the dollar, according to Citigroup Inc. analyst Michael Anderson.
JPMorgan, for its part, has significantly reduced its exposure to the leveraged loan market over the past year. Daniel Pinto, chief operating officer, recently told investors that the bank had reduced its share of deals done but not yet sold to 6% of the market in May, from more than 20% at the start of 2021. That share has fallen further since, according to a senior banker at the company who declined to be identified as the risk of being stuck with unwanted and unsellable debt has steadily increased.
When the market freezes or slows, banks may end up having to sell loans at low prices, which may reduce their fees or lead to outright losses, or they may have to keep them on their balance sheets, which reduces their ability to generate new revenue. new offers. At worst, they find themselves stuck lending to a company that cannot repay its debt. Banks guard against this by agreeing in advance with borrowers the option of selling loans at a discount or raising interest rates before selling, with the business bearing the costs. If a borrower disagrees, the loan is not taken out – and it happened this year.
Sales of new loans this quarter are at lower volumes even than during the start of the Covid pandemic in 2020. Two weeks to the end of June, the US market at $149 billion is on track for its most weak quarterly issuance since the first three months of 2015, according to data compiled by Bloomberg. In Europe, issuance currently stands at 5.9 billion euros ($6.1 billion), which is expected to be the worst since the first quarter of 2009.
It is above all the worries linked to the recession that make investors nervous. Leveraged loans pay a floating interest rate that increases with higher central bank rates. It’s good for investors up to a point; but when rates rise rapidly, higher debt service charges can quickly put borrowers in trouble.
For all risks, it’s not redux 2008 for leveraged loans for several reasons. During this crisis, banks around the world found themselves stuck with hundreds of billions of dollars in debt representing more than a quarter of the total market. Today, the volume of loans made and not sold is both lower value and a much smaller fraction of a much larger market.
Additionally, some investors are more willing to grab cheap deals when the market is in trouble. Citi’s Anderson notes that there is a flurry of so-called “print and sprint” transactions being made by secured loan bond managers. These debt-funded investment vehicles are created to quickly redeem existing loans that are trading at low prices, rather than spending weeks slowly buying new loans as they are created. As quick investors, they can help support prices in a jittery market.
Another difference over the past decade is the growth of private credit funds, which have become an industry of around $1.5 trillion. Some of the biggest managers, such as Blackstone Credit, Stone Point Capital or Antares Capital have become loan arrangers as well as investors, with the aim of increasing returns with additional fees and ensuring that they get a much of the loans they want. That means they’re in direct competition with investment bankers: In a recent deal for software company Kofax Inc., private lenders accounted for about half of the loan arrangers, according to Bloomberg. This might help spread the pain in a worsening downturn.
There are a lot of things that could go wrong with leveraged loans, especially if Western economies tip into recession. And some banks are always going to make bad calls to the companies they’re trying to bring to market. But for now at least, leveraged bankers appear to be facing a slowdown in earnings rather than impending balance sheet disasters.
More from Bloomberg Opinion:
• Decisive people are not better decision makers: Thérèse Raphaël
• The stock market has one more shoe to drop: John Authers
• How close are we really to the inflation of the 1970s? : Burgess, He and Winger
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Paul J. Davies is a Bloomberg Opinion columnist covering banking and finance. Previously, he was a reporter for the Wall Street Journal and the Financial Times.
More stories like this are available at bloomberg.com/opinion