Buyout Loans Sell at a Discount as Recession Fears Mount

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Last week, bankers led by JPMorgan Chase & Co. slapped the biggest discount seen in 2022 on a leveraged loan just to get the $1.5 billion deal off the books and into the hands of investors. The debt was sold at price equivalent to 89 cents for every dollar borrowed to back the merger of two private equity-owned companies, Material Handling Systems Inc. and Fortna Inc., Bloomberg News reported. That promises a handsome return to investors — but it’ll be disappointing, and possibly costly, for the banks involved. 

This is no one-off bad transaction. Borrowers and investors are seeing sharply rising interest costs and knockdown prices in the market for risky, junk-rated loans. The surge in inflation and fears of potential recessions that are playing havoc with stocks, bonds, currencies and crypto are hurting loans too. This is a problem for banks that underwrite loans and sell them to investment funds. The average discount on loans sold over the past month is the biggest in a decade with prices averaging 95.5 cents on the dollar, according to Michael Anderson, an analyst at Citigroup Inc.  

JPMorgan, for one, has dramatically cut its exposure to the leveraged loan market in the past year or so. Daniel Pinto, chief operating officer, told investors recently that the bank had cut its share of deals that have been agreed but not yet sold to 6% of the market in May, down from more than 20% at the start of 2021. That share has come down further since, according to a senior banker at the firm who declined to be identified, because the risk of getting stuck with unwanted, unsellable debt has kept growing.

When the market seizes up or just slows down, banks can end up having to sell loans cheaply, which can eat into their fees or lead to outright losses, or they have to hold them on their balance sheets, curtailing their ability to make fresh income from new deals. At worst, they get stuck lending to a company that can’t repay its debt. Banks guard against this by agreeing in advance with borrowers the flexibility to sell loans at discounts or increase the interest rates before they sell, with the company bearing the costs. If a borrower won’t agree, the loan doesn’t get underwritten — and that has been happening this year. 

Sales of new loans this quarter are at lower volumes even than during the onset of the Covid pandemic in 2020. With two weeks to go until the end of June, the US market at $149 billion is on course for its lowest quarterly issuance since the first three months of 2015, according to data compiled by Bloomberg. In Europe, issuance is currently 5.9 billion euros ($6.1 billion), set to be the worst since the first quarter of 2009. 

It is mostly recession concerns making investors nervous. Leveraged loans pay a floating interest rate that rises with higher central bank rates. That’s good for investors up to a point; but when rates rise rapidly, higher debt servicing costs can put borrowers in trouble quickly.

For all the risks, this is no 2008 redux for leveraged loans for several reasons. During that crisis, banks globally got stuck with hundreds of billions of dollars of debt representing more than a quarter of the total market. Now, the volume of loans agreed and not sold is both lower in value and a far smaller fraction of a much bigger market.

Also, some investors are more ready to scoop up cheap deals when the market struggles. Citi’s Anderson notes there is a wave of so-called “print and sprint” deals being done by managers of collateralized loan obligations. These debt-funded investment vehicles are created to rapidly buy up existing loans that are trading cheaply, rather than spend weeks slowly buying new loans as they are created. As fast investors, they can help underpin prices in a nervous market.

Another difference in the past decade or so is the growth of private credit funds, which have become a roughly $1.5 trillion-asset industry. Some of the biggest managers, such as Blackstone Credit, Stone Point Capital or Antares Capital have become arrangers of loans as well as investors, in a quest to boost returns with extra fees and ensure they get a good share of the loans they want. This means they compete directly with investment bankers: In a recent deal for software company Kofax Inc., private lenders made up about half of the arrangers on the loan, according to Bloomberg. This could help spread the pain in a worsening downturn.

There is plenty that could go wrong in leveraged loans, especially if western economies tip into recession. And some banks are always going to make bad calls on the companies they try to bring to market. But for now at least, leveraged-loan bankers look like they face a slowdown in earnings rather than any looming balance-sheet disasters.  

More From Bloomberg Opinion:

• Decisive People Aren’t Better Decision-Makers: Therese Raphael

• The Stock Market Still Has Another Shoe to Drop: John Authers

• How Close Are We Really to 1970s-Style Inflation?: Burgess, He & Winger 

This column does not necessarily reflect the opinion of the editorial board or 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.

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