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(Bloomberg)—Debt markets are increasingly sorting US leveraged loans into two categories: money good, and distressed.
A growing proportion of prices in the market are either very high, or very low. About 5% of the market is trading under 80 cents on the dollar, a share that has more than doubled since June, according to a JPMorgan Chase & Co. analysis. And more than half the market is trading above 96 cents on the dollar, an amount that has also more than doubled.
With more loan prices reaching extremes, companies that run into any sort of difficulty can see their loans plunge quickly. That can translate to surging borrowing costs, boosting the chance of corporations defaulting.
“This puts the worst companies at risk, as they’ll have a harder time refinancing,” said Roberta Goss, senior managing director and head of the bank loan and collateralized loan obligations platform at Pretium Partners LLC, in an interview.
The price movement stems from the biggest buyers of the debt, money managers that bundle it into bonds known as collateralized loan obligations. They face constraints against owning loans that are too risky — in particular, those rated in the CCC tier, and in many cases they’re getting closer to that level, making them less willing to buy anything potentially problematic.
As US economic growth shows signs of slowing, more loans are being downgraded — November saw the most cuts for issuers since May 2020, according to JPMorgan. CLO managers are avoiding CCC loans, or even loans close to getting downgraded to that level.
Last week, S&P Global Ratings downgraded Aventiv Technologies LLC, a company that provides phone service to prison inmates, by one notch to CCC+. One of its loans fell to around 77 cents on the dollar from about 84 cents in a matter of hours.
With loans looking either expensive or untouchable for CLOs, it’s more difficult for money managers to find enough of the debt to bundle into the securities. That’s part of why CLO issuance has fallen so much this year: about $130 billion have been sold in 2022, down around 30% from last year.
“It’s becoming more challenging to find loans at attractive prices,” said Joseph Rotondo, senior portfolio manager at MidOcean Credit Partners. “The core CLO names are trading over 97 cents on the dollar, while most CCCs and weak B3 names keep trading down to the low 80s and 70s.”
The average price for leveraged loans hasn’t changed much in the last six months, hovering around 92 cents on the dollar. But loans trading above 96 cents on the dollar now account for almost 55% of the US universe, while they were just a little over 23% in late June, according to data from JPMorgan.
On the other end, loans below 80 cents stand at almost 5.2% of the index, according to JPMorgan. In late June, that proportion was about 2.4%.
“There’s a universe of loans everyone is chasing and another one that no one is buying,” said Pretium’s Goss.
CCC Limits
CLO managers are reluctant to take risk because of guidelines that often discourage them from having more than 7.5% of their holdings in the CCC tier. Above that level, money managers may have to cut down or cut off payments to the owners of the riskiest bonds they sell, known as the equity portions, a step that can make it harder for CLO managers to sell bonds in the future.
US CLO managers now have an average of about 5.6% of their portfolio in CCCs, according to Bank of America Corp. estimates as of Dec. 16. About 20% of CLOs are breaching their concentration limits, according to the bank, up from 10% in late October.
And a relatively large portion of their loans are at risk of getting cut to the CCC tier: according to S&P, about 30% of CLO portfolios are made up of B- loans, those one step above the danger zone. That’s a record high proportion, forcing managers to make tough decisions over which loans to drop to ensure their portfolios don’t get hit.
Downgrades have already started. Leveraged loans from companies such as Cision Ltd., which makes databases for public relations professionals, and Symplr, which makes enterprise software for healthcare organizations, have been cut in recent weeks to the CCC tier from the B tier. November was the seventh straight month where downgrades exceeded upgrades, according to a JPMorgan report last week.
“Companies with debt trading below 80 cents are definitely bruised and could face real headwinds if they need to refinance their liabilities in the next couple of years,” said Rob Zable, chief investment officer for Blackstone’s liquid credit strategies, in an interview.
–With assistance from James Crombie.
© 2022 Bloomberg L.P.
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