People have several ways to bet that interest rates might rise. One method has been falling out of favour for most of this year.
The obvious approaches are 1) selling interest rate futures or 2) borrowing bonds in the repo market to sell them for cash. The main advantage of these techniques is that they let you pick which specific interest rates you want to bet on while leaving the others alone. For example, you might think that the one-year sovereign interest rate three years from now implied by the prices of three-year and four-year notes is unreasonably low but every other interest rate on the curve seems about right. You should short the four-year note and buy the three-year note. Read more
Last year the Federal Reserve and the Office of the Comptroller of the Currency issued new leveraged lending guidance designed to discourage big banks from underwriting risky new loans. Off the menu were loans with more than six times leverage, or that exhibited certain signs of weak underwriting or covenants. Since then, the regulators have double-down on the guidance — warning banks they should hardly ever do loans that are unlikely to pass muster.
So, more than a year later, it’s worth asking whether the guidance has had any effect. Read more
They are billed as a quick and easy way for investors to gain access to higher-yielding assets while still providing some protection if interest rates start to rise. They are ETFs which track portfolios of (floating-rate) bank loans.
And they are on fire. Read more
So how is it going with new issuance in the high yield debt markets for corporate Europe? Middle-market investment bank RW Baird has the answers in its Global Leveraged Loans Quarterly, out this Thursday. Highlights:
Key Findings: Read more
Back in December, the FT’s Tracy Alloway and Robin Wigglesworth explained how that which was financed by collateralised loan obligations was no longer going to be so financed. This will lead to a credit crunch for sub-investment grade companies that looks set to kick off in earnest in a couple of years.
Older CLOs* are making up for some of the slack by extending loans, but it appears that ultimately, funding will have to be obtained elsewhere or these companies will default. Read more
Here’s one inevitable consequence of the European bank deleveraging we’ve all been anticipating:
US banks have rushed to supply companies with leveraged loans for refinancing higher-yielding debt in recent weeks, the WSJ says. The leveraged loan market saw $36bn of activity in August. While that is half the monthly average, it compares to $2bn raised via junk bonds and IPOs. Banks have supported the market in order to put cash on their balance sheets to work, analysts said. The leveraged loan market remains far below its pre-crisis peaks, with $10-15bn advanced by banks in September compared to $192bn in September 2007.
Investors pulled the most money from global stock funds since 2008 in the past week, Bloomberg reports. Funds that buy global equities suffered $3.5bn in net withdrawals in the week ending August 10, the most since the second week of October 2008, according data provider EPFR Global. Investors removed $11.7bn from funds that invest in US equities, the most since May 2010 when investors pulled money following a one-day market crash that briefly erased $862bn. Meanwhile leveraged loans had their worst showing last week since the financial crisis, the FT reports. Investors had put record amounts of cash into these investments over the past year, lured by their floating rate, when the expectation was that the economy would continue to improve and interest rates were likely to rise. Funds reduced bets on rising commodity prices by the most in any week since February 2010, Bloomberg says. In the week to August 9, speculators cut their net-long positions in 18 commodities by 19 per cent to 989,110 futures and options contracts, CFTC data show. Copper holdings plunged 61 per cent, the most since June 2010, and bullish gold bets fell to a five-week low. Meanwhile, money markets attracted net inflows of $49.8bn only a week after registering record outflows, in the FT. Equity funds had more money pulled out of them than at any time since early 2008, while investors moved faster out of risky junk-rated bonds than at any time since records began in 2005.
An uptick in mergers and acquisition activity is set to boost issuance in the US leveraged finance market as investors in Europe strike a note of caution on market dynamics there, according to the FT. Leveraged loan and junk bond issuance has been strong in the US this year, driven by companies’ efforts to refinance debt borrowed during the credit boom of the past decade. Bankers and market experts, however, are now pointing to a growing pipeline of deals related to M&A. The need for new money for loans and bonds to finance M&A deals, rather than refinance existing debt, could help to ease what has been a cash glut in both markets this year and reduce the instance of controversial financing structures, which have returned in the rally.
Renewed acceptance of a so-called covenant-lite loans “may be laying the groundwork for painful fallout from the next credit downturn,” Moody’s has warned, according to the FT. To the surprise of many observers, covenant-lite loans had a lower instance of default during the financial crisis than loans with traditional terms — likely because only stronger borrowers were able to borrow on cov-lites’ generous terms in the first place. New covenant-lite loans have soared this year as investors have poured money into low-rated, or leveraged, corporate loans as hedges to rising interest rates. However, Moody’s says, low rates themselves have masked the risks of cov-lite loans.
The Moody’s monthly report on speculative-grade default rates was released on Thursday, and it’s good news for investors with high-yield bonds and leveraged loans in their portfolios:
The issuer-weighted global speculative-grade default rate finished the third quarter at 4.0%, down from 6.2% in the second quarter. The global default rate is now below its historical average of 4.8% for the period of 1983-2009. On a year-over-year basis, the global rate has fallen more than two-thirds from a level of 13.2%. This decline corresponds closely with what we expected one year ago when Moody’s default rate forecasting model predicted a 4.5% rate. Read more
Whither all those rubbish European bank assets?
There are plenty of soured loans lingering in the system, on top of a €500bn-outstanding leveraged loan market still being shaken out. Read more
The leveraged-loan market has climbed back from its collapse during the crisis, recording its busiest year since 2008 as investors chase yield, reports the WSJ. A quarter of issuance is now based around leveraged buyouts rather than refinancing old loans — while more companies are using the debt to pay dividends. Investors are however resisting dividend strategies, indicating the market isn’t as bubble-prone as before the crisis. Maybe, says FT Alphaville; investors would do better to focus on the $550bn of leveraged loans that will have to be refinanced in 2013 and 2014.
Earlier in August, we looked at various reasons for why this year’s junk bond rally had been surprisingly persistent.
But how does this relate to the market for junk loans, better known as speculative-grade or leveraged loans? Read more
Earlier this month, FT Alphaville asked whether synthetic CLOs were gone for good, or merely hibernating?
This week it looks like the synthetic CLOs’ simpler cousin, your run-of-the-mill business loan-packed CLO, is beginning to awaken: Read more
How often do you see a research report on UK property kicked off by a Jimi Hendrix quote?
The third edition of JP Morgan’s annual European Property Handbook came out earlier this week, and it makes for poetic, if disturbing reading. Read more
As with wine, the structure of a loan will depend on the year it was created. Some loans have more generous terms for borrowers, for example, reflecting the higher appetite for risk that permeated the financial world at the time. Others will be more harsh in their flavours, a function of tighter credit conditions.
In any case, Commerzbank/Dresdner’s credit team have an interesting analysis of leveraged loan vintages out this Monday morning, while making the case that corporate defaults are in for something of a sudden acceleration: Read more