The slowdown on Wall Street’s $1.4tn junk-rated loan market is affecting corporate America, forcing a growing number of companies to either pay more or abandon their borrowing plans.
The market for CLOs (collateralised loan obligations), the investment vehicles which own two thirds of the low-rated US corporate debt, has been impacted by changes.
According to sources with knowledge of the situation, a loan extension for California utility PG&E has been canceled. Heartland Dental, a service provider to dentists, and Internet Brands, a digital media company, were required to pay more to lenders or accept tougher investor protections as recompense for extending their loan maturities.
In general, CLOs are limiting their debt purchase — reducing the funding options for lower-rated borrowers – due to limitations on what and when they can buy. They also have to consider the economic climate.
This in turn is driving up the cost to borrow for many US-based companies.
When a company needs to find new lending sources. . . This will probably have an impact on capital costs, because you need to make the investment attractive for new lenders,” said Rob Zable. He is the global head of Blackstone’s liquid credit strategy.
In the last decade, the market for leveraged loan has been a vital funding source for both US companies and for private equity groups that are buying up businesses. This shift is particularly important because the banks have reduced some of their lending before the financial crises.
CLOs purchase hundreds of loans, package them, and then use the interest they generate to fund additional debt slices, which are sold to banks, insurance companies, and other investors. They are still governed by their “reinvestment periods”, in which CLOs may use the revenue they generate to purchase new debt. After this period, the CLOs must use these funds to pay off their debt.
Bank of America’s Pratik Gupta believes that, by the end of this year, roughly 40% of CLOs are expected to exit their reinvestment period. This will reduce the demand for new loan.
The number of triple C-rated loans that CLOs can purchase has also been limited. This is one of the lowest ratings of credit rating the major agencies can give.
Some CLOs are also more concerned with the low-rated loans they hold due to the rise in interest rates.
The US Federal Reserve kept its benchmark interest rate, or fed funds rate, between 5 and 5,25 per cent last week, but chairman Jay Powell indicated that further increases were coming.
A slowing economy and higher interest rates will also affect corporate profits. Rating agencies have projected an increase in corporate defaults. Managers of CLOs are hesitant to purchase especially risky loans.
John McClain is a Portfolio Manager at Brandywine. He said that the impact of rising interest rates can be felt right now.
The failures of Silicon Valley Bank and Signature Bank, both in March, have had knock-on effects.
Gupta stated that after the stress tests last year, large banks, who are traditionally major buyers of CLOs had “really begun to step away” from this market.
He said that banks are now “a little more conservative” in how they allocate their [securities] to portfolios because of the higher capital charges. Some investors said the market’s problems would lead to increased borrowing costs until demand for new CLOs picked up.
Some companies have opted to sell fixed-rate debt as high-yielding bonds, or take out loans with shorter maturities instead of tapping the CLO markets.
Heartland partially repaid a loan that was due to mature in April of 2025, after raising funds on the bond market. It also received new capital from the Ontario Teachers’ Pension Plan and asset manager KKR. In exchange for the extension of the maturity date, Heartland had to raise the interest rate up to 1.25 percentage points.
Heartland Energy, PG&E, and Internet Brands have not responded to our requests for comment.