Can a Revived Junk Bond Market Prevent a Loan Blowup?

Posted by: Ben Levisohn on June 8, 2009

Where’s the next financial blowup coming from? The Deal’s Vipal Monga lays out the case for the leverage loan market. $450 billion dollars of loans need to be repaid between 2012 and 2014 and that’s a big problem.

Companies rarely pay the loans back with their own cash. Instead, they take out a new loan and pay the old one back. But the market for those loans is pretty limited. Pre-credit crisis, they were packaged into collateralized loan obligations. With the CLO market all but dead, “an inevitable spate of defaults and restructurings… will result,” says Reuter’s Felix Salmon.

But there is a sliver of hope and it’s called the junk bond market, says Guggenheim Investment Advisor’s chief investment officer Charles Stucke.

At the end of 2008, the junk bond market was all but dead (Bloomberg data shows a mere $3.43 billion from seven issues). Few companies could afford to bring a new issue to market nor would investors have been lining up to buy them. What a difference a couple of quarters make. We still have a few weeks until the end of June, but junk bond issuance has already hit $39.22 billion from 77 companies, more than was issued during the same period in 2008. That money could go to paying off maturing loans.

Clearly, a lot has to go right. Investor demand for junk needs to remain high and get a lot higher (something I doubt will happen as spreads between investment grade and high yield narrow). And companies have to plan better than their history suggests they’re capable of doing. But even the slimmest of chances is better than no chance — isn’t it?

Reader Comments

The Mad Hedge Fund Trader, San Francisco, CA

June 12, 2009 12:14 AM

High yield bonds, less politely known as “junk”, have seen a dramatic improvement in the past month, making it the best performing fixed income asset class this year. With junk default rates expected to skyrocket this year, and a huge backlog of new supply overhanging the market, investors have been staying away in droves. Last year yields shot up as high as 25%, implying improbable future default rates of over 75%. The actual Q1 default rate came in at only 7.0%, up from 1.5% a year earlier, and rating agency Moody’s sees a worst case scenario of 14.6% this year. But a strong stock market and the opportunity cost of zero short term interest rates was enough to entice players off of the sidelines, who snapped up $7 billion in securities in April. The improvement in conditions is a welcome blast of fresh air to companies in debt heavy industries like REIT’s, hotels, and property developers. www.madhedgefundtrader.com

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About

Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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