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US companies have been able to reprice almost $400bn of debt at lower interest rates this year due to booming investor appetite for junk loans, in an easing of financing conditions for corporate America.
Even before the Federal Reserve cuts interest rates from a 23-year high, a number of borrowers in the US leveraged loan market have benefited from the equivalent of two quarter-point Fed cuts, according to strategists at Goldman Sachs.
The $391bn of so-called repricing deals is the highest ever at this point in the year, according to data from PitchBook LCD going back to 2002, equal to more than a quarter of the $1.34tn leveraged loan market.
Demand has been driven by investment vehicles that repackage and sell on risky loans and by fund managers. A record share of this year’s issuance has been borrowers rolling over loans, rather than selling new debt before the Fed has cut rates. This has left investors fighting over a limited pool of loans.
“We don’t have the supply of loans to actually feed into that demand for new issuance, and that just means that investors are competing for the same assets,” said Bob Schwartz, a portfolio manager at AllianceBernstein. “There’s nothing else to buy. That just fuels the repricing wave.”
The figures are a boost to highly indebted companies that have suffered as the Fed has kept borrowing costs at 5.25 to 5.5 per cent in order to finish its fight against the biggest surge in inflation in a generation. Predictions about the future path of monetary policy have fluctuated wildly in recent months: investors expected six or seven rate cuts this year back in January, but are now betting on fewer than two.
In one of this year’s largest deals, Cloud Software Group, parent company of Citrix, lowered borrowing costs on a $6.5bn loan by 0.5 percentage points to 4 percentage points above the overnight benchmark rate, according to a person familiar with the transaction.
Healthcare company Medline reduced the spread on a $6.1bn loan from 3 to 2.75 percentage points in March.
This year’s wave of repricings — which differ from refinancing deals, in which companies issue fresh loans to replace maturing debt — has come amid particularly strong demand for leveraged loans, whose coupons are floating and linked to prevailing US interest rates.
Demand has outstripped supply, pushing the price of existing loans above their face value and therefore enabling companies to reprice them at lower borrowing costs. Thirty-nine per cent of the junk loan market was priced at or above par last Friday, according to the PitchBook LCD data, down from a peak of 65 per cent in mid-May but still substantially higher than just 2.4 per cent a year ago.
The current situation is a “paradox”, said Goldman’s chief credit strategist Lotfi Karoui. “The delayed start to the easing cycle has ended up actually boosting inflows into bank loans as an asset class — and that’s boosting prices, pushing them above par or around par, and making the economics of repricing quite attractive for borrowers.”
Much of the demand is being driven by surging issuance of so-called collateralised loan obligations, which buy junk loans and package them into different risk categories and sell the tranches on to investors.
Issuance of CLOs, which account for roughly two-thirds of demand for US leveraged loans, has almost doubled to $100bn so far in 2024, the PitchBook LCD figures show, the highest year-to-date figure since at least 2012.
One banker pointed to “a lot of energy” around the buying of triple-A grade CLO tranches in recent months, which they said was driving even faster creation of these vehicles.
Issuance of new leveraged loans, meanwhile, has not increased at the same pace as demand from CLOs and other loan investors.
Some low-grade companies had also been able to cope with a high interest rate environment better than feared, helped by the US economy proving more robust than expected, said bankers and investors.
“It’s almost the perfect storm of really healthy fundamentals, really healthy investor interest in the asset class, elevated base rates [and] a pretty benign default environment,” said Brian Barnhurst, head of global credit research at PGIM.
However, the opportunity to push down costs had largely been open to higher-quality junk loan issuers, while the weakest borrowers had been left behind, said investors and analysts. They added that even after the recent flurry of repricing deals, interest expenses for loan issuers remained much higher than just a few years ago because US interest rates were higher.
Reducing interest costs of 8 or 9 per cent by 0.5 or 0.75 percentage points should certainly help a company, said Schwartz, “but you didn’t just cut your debt cost in half . . . it’s not like a game-changer”.
