Here’s one inevitable consequence of the European bank deleveraging we’ve all been anticipating:
Via S&P Leveraged Commentary & Data, the chart shows the widening gap between the leveraged loan rate in Europe and in the US since August. The difference is now at its highest point on record, according to LCD.
Other than European banks dumping their asset portfolios, a few factors, both fundamental and technical, might partially be contributing to the gap. First, funding costs are clearly higher in Europe, a fact which will be feeding through to leveraged loan markets. Default rates for US companies, meanwhile, are also lower than in Europe, and the US market benefits from a larger pool of investable money in the form of CLOs and retail-focussed mutual funds. But these factors were present well before the divergence at the end of the summer.
In its report, LCD points to this Dealbook story about US private equity shops, distressed debt and sovereign wealth funds “licking their chops” at the prospect of scooping up some of these assets at such attractive yields. (PricewaterhouseCoopers estimates that the total value of asset sales by European banks could reach $1,800bn, though as we’ve mentioned a few times, many of these sales will involve cross-border assets.)
But we suspect there’s a limit to how much of a saviour these outside buyers might turn out to be.
These investments will come with big risks, both because the European sovereign debt crisis has no visible end and because of how close Europe is to another recession. And the deleveraging itself could well be the cause of a downturn, leading to a further climb in default rates on these loans, higher yields, and so forth — the start of a frightening feedback loop.
In other words, even if some buyers enter the market and push down yields a bit, barring a dramatic political breakthrough there’s probably a yield floor beneath which buyers will stop showing interest. There are plenty of good reasons for the prices of these loans to have fallen, and not many for them to climb again.
(There’s also the issue of whether the European Banking Authority will walk its tough talk about preventing excessive deleveraging, an issue we won’t get into now.)
Regardless, pretty soon it will be safe to say that the long-expected crunch de crédit is no longer looming; it’s here.
Related links:
More lessons from bank recap history – FT Alphaville
Honey, I shrunk emerging Europe – FT Alphaville
The looming crunch de crédit – FT Alphaville
Here comes the (cross-border) bank deleveraging – FT Alphaville