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— Analysis —
"Everyone is very gun shy," says Martin Fridson, CEO of credit investment management firm Fridson Investment Advisors. That reluctance by bond and loan investment funds to put their money to work has pushed bids for high-yield credit to record lows. Standard & Poor's Leveraged Commentary & Data unit said Sept. 30, after the U.S. House of Representatives rejected a $700 billion bailout package, that average bids for an index of the 15 largest high-yield bonds fell 312 basis points in the third quarter, to 77.48% of par value, an all-time low. LCD's index of the 15 largest loans fell 260 basis points over the past three months, to an average bid of 79.88% of par.
-- Browse other stories in this Special Report -- Enter the giants Big, big and beyond Chain of fools Brrrrrrrr Neither short nor sweet Doffing the cap LCD said prices weren't just being pressured by the bailout bill's difficult passage through Congress, but also by fears triggered by Lehman Brothers Holdings Inc.'s bankruptcy, Washington Mutual Inc.'s failure and the takeovers of Merrill Lynch & Co. and Wachovia Corp., not to mention the government rescue of American International Group Inc. Lehman Brothers, in particular, weighed down the market. One banker says that after its Chapter 11 filing, the investment bank tried to unload a portfolio of $825 million in loans into the market, further depressing prices. The bank then pulled the offer without explanation. "Prices still haven't rebounded from that maneuver," the banker says. Adding to the negative tone are trends pointing to increased default rates. Moody's Investors Service noted in a Sept. 8 report that the global speculative-grade default rate had jumped to 2.7% in August, almost double last year's 1.4% rate. In the U.S., the rate in August hit 3.3%, which was also up from 1.4% a year ago. Moody's said the upward trend will continue "well into 2009" but hedges its prediction that defaults will rise to 4.9% by year's end and to 7.4% a year from now. "How high default rates eventually climb will depend in large part on the extent and duration of the developing global economic slowdown," the report said. Not helping the situation is the dramatic rise in interest rates, especially in the loan markets, which are priced off LIBOR and reset every quarter. In light of a money-market freeze, LIBOR rates have been surging, and, as of Oct. 1, were at 4.05%, up from 2.81% a week ago. That increase in interest costs is pressuring issuers, says one banker, which could push some into default and will make refinancing debt that is maturing much more difficult. "The restructuring that's coming has gone from being a wave to a tsunami," the banker says. Mitigating some of the gloom, however, is that investors in both the
loan and bond markets have been collecting cash from interest payments
in the absence of any new issuance. "Cash is building; it's just a
question of when Amid the gloom, there are signs that investors may be willing to step in, even if for small amounts and for strong companies. And who knows what will happen if Congress passes the bailout plan? It's not as though nothing is moving. There have been three loans of some size priced in the past few weeks, including a $1 billion credit for biotech company Invitrogen Corp. on Sept. 19, a $1.1 billion term loan for Brocade Communications Inc. on Sept. 25 and a $1.5 billion loan for pharmaceuticals company Fresenius SE. All were priced at discounts of par and had high yields priced between LIBOR plus 350 basis points and LIBOR plus 400. In the bond market, SunGard Data Systems Inc. was able to price $500 million of bonds to fund its purchase of French software company GL Trade SA. The bonds were priced at a discount, yielding 10.875%, and then traded over par. "The market isn't dead, but it's close," a banker says. |
A deep freeze has descended on the leveraged financing markets. As loan and bond prices hit record lows, investors are delaying proposed financings and girding for a wave of defaults. Still, cash continues to accumulate in accounts, and there is a sense that an eventual thaw will create great opportunities for investors.
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