Title: Corporate America Faces Challenges as Wall Street’s Junk Loan Market Slows
Introduction:
Corporate America is feeling the impact as the $1.4 trillion market for junk loans on Wall Street slows down. With the market for covered loan obligations (CLOs) undergoing changes, many companies are being forced to pay higher costs or abandon loan plans. This slowdown is driven by CLOs limiting their debt purchases, reducing funding options for low-rated borrowers. As a result, the cost of borrowing for US companies is on the rise. This article explores the implications of these changes and the challenges faced by Corporate America.
Unfavorable Market Conditions and Loan Extensions:
1. Loan extension for California utility PG&E shelved: Last month, PG&E’s loan extension was halted due to changes in the market for CLOs. This highlights how borrowers are affected by the evolving lending landscape.
2. Heartland Dental and Internet Brands pay lenders more for loan extensions: In order to extend their loan maturities, dental service provider Heartland Dental and digital media firm Internet Brands were required to pay lenders more and agree to tougher investor protections. This showcases the increasing costs faced by borrowers.
CLOs Curbing Debt Purchases:
1. Limits on when and what CLOs can buy: Many CLOs are imposing restrictions on their debt purchases, which directly impacts the funding possibilities for lower-rated borrowers. These limitations are a response to changes in the economic environment.
2. Borrowing costs rising for US companies: The need to find new lenders due to limited access to CLOs is driving up the cost of capital for many US companies. The attractiveness of borrowing has to be increased to attract new lenders.
The Significance of the Leveraged Loan Market:
1. Leveraged loan market as a key funding source: Over the past decade, the leveraged loan market has become a crucial funding source for both US companies and private equity groups. This shift was necessitated by reduced lending from banks after the financial crisis.
2. Role of CLOs in the market: CLOs purchase diverse loans, package them, and use generated interest payments to fund new debt. Once the reinvestment period of CLOs expires, they must utilize the accumulated funds to settle obligations.
CLOs Facing Challenges and Increasing Debt Concerns:
1. Reinvestment periods ending: By the end of the year, it is expected that about 40% of CLOs will reach the end of their reinvestment periods. This diminishes the demand for new loans.
2. Limits on purchasing low-rated debt: Many CLOs have hit their limits on purchasing triple-C loans, which are among the lowest-rated credit loans. This reflects growing concerns about holding risky debt.
Negative Effects of Rising Interest Rates and Economic Slowdown:
1. Impact of interest rate hikes: The US Federal Reserve’s decision to keep benchmark interest rates between 5 and 5.25% increases pressure on corporate profit margins. Rising interest rates coupled with a slowing economy affect revenue growth.
2. Reluctance to buy risky loans: CLO managers exhibit reluctance to invest in particularly risky loans due to concerns over rising interest rates and potential corporate defaults.
Additional Piece: How Corporate America Can Navigate the Changing Loan Landscape
The current slowdown in the junk loan market and the challenges faced by Corporate America necessitate strategic responses to ensure financial stability and continued growth. Here are some insights on how companies can navigate this changing landscape:
1. Diversify funding sources: Relying solely on CLOs for loan access can be risky in turbulent times when CLOs are curbing debt purchases. Companies should explore alternative options such as high-yield bonds or shorter-term loans to diversify their funding sources.
2. Strengthen investor relations: Maintaining strong relationships with existing lenders and investors can provide access to additional financing options. Transparent communication and demonstrating a solid business strategy can instill confidence in lenders and attract new investors.
3. Review debt management strategies: In light of rising interest rates and concerns over the economic environment, companies should review their debt management strategies. Taking proactive measures to reduce debt burden, negotiate favorable terms with lenders, and improve creditworthiness can help mitigate risks.
4. Embrace innovation and adaptability: Companies must identify opportunities to innovate and adapt to market changes. Incorporating technological advancements and staying ahead of industry trends can enhance competitiveness and attract potential investors.
5. Monitor market conditions and seek expert advice: Staying updated on changing market conditions and seeking advice from financial professionals can provide valuable insights. This can help companies make informed decisions regarding borrowing costs, loan structures, and investment opportunities.
Conclusion:
As the junk loan market slows down and the landscape for CLOs undergoes changes, Corporate America is facing challenges in accessing affordable loans. The tightening of lending conditions requires companies to adapt and explore alternative funding sources while minimizing risks. By diversifying funding, maintaining investor relations, reviewing debt strategies, embracing innovation, and staying informed, companies can navigate the changing loan landscape and position themselves for success in corporate finance.
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Corporate America is feeling the pinch as Wall Street’s $1.4 trillion market for junk loans slows, with a growing list of companies being forced to pay more or abandon loan plans.
Borrowers have been hit by changes in the market for covered loan obligations, or CLOs, the investment vehicles that own about two-thirds of low-rated US corporate loans.
A loan extension for California utility PG&E was shelved last month, while Heartland Dental, a provider of dental practice services, and digital media firm Internet Brands had to pay lenders more o agree to tougher investor protections in exchange for extending loan maturities, according to people familiar with the matter.
More broadly, many CLOs are curbing their debt purchases, limiting the funding possibilities of lower-rated borrowers, due to limits on when and what they can buy, as well as the broader economic environment.
This, in turn, is driving up the cost of borrowing for many US companies.
“When a company has to find new lenders . . . this probably has an impact on the cost of capital because you have to make it attractive to new lenders,” said Rob Zable, global head of liquid credit strategies at Blackstone.
Over the past decade, the leveraged loan market has become a key funding source for both US companies and private equity groups taking over businesses. The change was particularly significant because banks reduced some of the lending they were doing before the financial crisis.
CLOs buy hundreds of different loans, package them up, and use the interest payments they generate to fund new debt, which they then sell to banks, insurers, and other investors.
But they are governed by rules for their so-called “reinvestment period,” during which CLOs can use the revenues they generate to invest in new debt. Once this period has expired, they must use these sums to settle their obligations.
Bank of America strategist Pratik Gupta estimates that by the end of the year about 40% of CLOs will end their reinvestment periods, reducing demand for new loans.
Many CLOs have also already reached limits on the number they can purchase triple-C loans, one of the lowest credit ratings major agencies can assign.
At the same time, some CLOs have become more concerned about the low-rated debt they already hold, largely due to rising interest rates and its impact on the broader economy.
Last week the US Federal Reserve kept its benchmark interest rate, or Fed Funds, between 5 and 5.25%, but presided signaled Jay Powell further excursions would come.
Higher interest rates are expected to weigh on corporate profit margins, while a slowing economy is also affecting revenue growth. With rating agencies predicting an increase in corporate defaults, CLO managers have shown some reluctance to buy particularly risky loans.
“The weight of the rate hike is starting to take its toll now,” said John McClain, portfolio manager at Brandywine.
THE failures of Silicon Valley Bank and Signature Bank in March also had knock-on effects.
The BofA’s Gupta said big banks, traditionally big buyers of CLOs, had already “began to pull away” from the market after stress tests were completed last year.
He added that after this year’s bankruptcies, banks are now “a little more prudent in deciding how to allocate [securities] portfolio” because they had higher capital requirements.
Some investors have said that market issues will lead to higher funding costs until demand for new CLOs increases.
As an alternative to accessing the CLO market, some companies are now selling fixed-rate debt in the form of high-yield bonds or opting for shorter-term loans.
Heartland partially repaid a loan due in April 2025 after raising funds in the bond market and getting fresh capital from its owners: asset manager KKR and Ontario Teachers’ Pension Plan. But in exchange for extending the remaining loan term, it also had to raise the interest rate by as much as 1.25 percentage points.
Heartland, PG&E and Internet Brands did not respond to requests for comment.
https://www.ft.com/content/b3d4291f-857c-46c5-96b8-e67933b6e7e8
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