Corporate America is feeling the pinch from the slowdown in Wall Street’s $1.4tn market for junk-rated loans, with a growing list of companies forced either to pay more or abandon borrowing plans.
Borrowers have been hit by shifts in the market for collateralised loan obligations, or CLOs, the investment vehicles that own roughly two-thirds of lowly rated US corporate loans.
A loan extension for California utility PG&E was shelved last month, while Heartland Dental, a provider of services to dentists’ offices, and digital media business Internet Brands had to pay lenders more or agree to tougher investor protections in return for extending loan maturities, according to people with knowledge of the matter.
More generally, many CLOs are reining in their debt purchases — restricting the financing possibilities of lower-rated borrowers — because of limits on when and what they can buy as well as the broader economic environment.
That, in turn, is pushing up the cost of borrowing for many US companies.
“When a company has to find new lenders . . . that probably has an impact on the cost of capital because you have to make it interesting for new lenders,” said Rob Zable, the global head of Blackstone’s liquid credit strategies.
Over the past decade the market for leveraged loans has become a critical funding source both for US companies and private equity groups snapping up businesses. The shift has been particularly significant because banks have curtailed some of the lending they did before the financial crisis.
CLOs buy up hundreds of different loans, package them and use the interest payments they generate to fund new slices of debt, which are then sold on to banks, insurers and other investors.
But they are governed by the rules for their so-called “reinvestment period”, during which CLOs can use the revenues they generate to invest in new debt. Once this period has lapsed, they have to use such monies to pay down their obligations.
Bank of America strategist Pratik Gupta estimates that by the end of the year roughly 40 per cent of CLOs will exit their reinvestment periods, reducing the demand for new loans.
Many CLOs have also already hit their limits on the number they can buy of triple C loans — one of the lowest credit ratings the major agencies can assign.
At the same time, some CLOs have become more concerned about the low-rated debt they already hold, largely because of the increase in interest rates and its impact on the wider economy.
The US Federal Reserve last week kept its benchmark, or fed funds, interest rate between 5 and 5.25 per cent but chair Jay Powell signalled further hikes were to come.
Higher interest rates are expected to weigh on corporate profit margins, while a slowing economy is also hitting revenue growth. With rating agencies projecting an uptick in corporate defaults, managers of CLOs have shown some reluctance to buy particularly risky loans.
“The brunt of rising rates is starting to be felt now,” said John McClain, a portfolio manager with Brandywine.
The failures of Silicon Valley Bank and Signature Bank in March have also had knock-on effects.
BofA’s Gupta said that large banks, traditionally big buyers of CLOs, had already “really started stepping away” from the market after stress tests were completed last year.
He added that after this year’s failures, banks were now “a bit more conservative in deciding how to allocate to their [securities] portfolio” because they anticipated higher capital charges.
Some investors said the market’s problems would lead to increased borrowing costs until demand for new CLOs picked up.
As an alternative to tapping the CLO market, some companies are now selling fixed-rate debt in the form of high-yield bonds or opting for shorter-maturing loans.
Heartland partially paid down a loan set to mature in April 2025 after raising money in the bond market and obtaining new capital from its owners — asset manager KKR and the Ontario Teachers’ Pension Plan. But in return for extending the maturity of the remaining loan, it also had to increase the interest rate by as much as 1.25 percentage points.
Heartland, PG&E and Internet Brands did not respond to requests for comment.