Bloomberg News

Leveraged-Loan Prices Turn Positive as Bid for Risk Resurfaces

September 02, 2011

Sept. 2 (Bloomberg) -- Prices of high-risk, high-yield loans rebounded this week from the biggest monthly decline since November 2008, as investors returned to riskier asset classes on expectation of further economic stimulus by the Federal Reserve.

The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index rose 0.44 cent to 89.5 cents on the dollar yesterday. The measure, which tracks the 100 largest dollar-denominated first- lien leveraged loans, had its biggest two day gain since May 2009, after losing 5.7 percent in August. Citigroup Inc. is raising a $395 million collateralized loan obligation to be managed by Apidos Capital Management.

Investors have begun to return to riskier assets on the hopes of a third round of quantitative easing by the Fed after concerns grew that the European sovereign-debt crisis and flagging U.S. economic news could be an indication of a stalled global recovery. The cost to raise money in the leveraged-loan loan market last month increased to the highest level in more than a year.

“The bid for risk disappeared during the first week in August, and we’ve been building a base over the last few weeks,” Christopher Garman, president of Orinda, California- based Garman Research LLC, said in an e-mail yesterday. “The recent rebound in risk assets has picked up steam based on expectations of a QE3.”

Returns on leveraged loans, which are rated below Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s and Fitch Ratings, fell from 2.04 percent at the beginning of August to negative 2.94 percent at the end of the month. Returns for August were down 4.91 percent.

The S&P 500 Index fell 5.68 percent in August to 1,218.89. The index was up 2.35 percent this week through yesterday, closing at 1,204.42.

Federal Reserve Pledge

The Federal Open Market Committee pledged in its Aug. 9 statement to keep its key interest rate at a record low at least through mid-2013 in an attempt to boost the economic recovery. The benchmark interest rate has been at zero to 0.25 percent since December 2008.

Federal Reserve Chairman Ben S. Bernanke said Aug. 26 at a conference in Jackson Hole, Wyoming, that the central bank still has tools to stimulate a recovery that has been weaker than forecast. At last year’s event, he foreshadowed the Federal Open Market Committee’s second round of quantitative easing when it purchased $600 billion of Treasuries.

“Fed Chairman Bernanke, in his Jackson Hole speech, sought to reassure the market the Fed will do all it can to restore higher growth and employment while maintaining price stability, but stopped short of signaling QE3 was imminent,” analysts wrote in an Aug. 29 Babson Capital Market research report. “He also implied lawmakers could be more helpful creating pro-growth fiscal policies.”

Loan Spreads

The spread on first-lien institutional term loans for all speculative-grade corporate ratings rose to 5.24 percentage points on Aug. 25, the highest level since July 2010, according to S&P’s Leveraged Commentary & Data. The average spread was at a record low of 2.43 percent in March 2007.

Companies sold $3.02 billion of new debt last month, down from $27.6 billion in July and this year’s peak of $69.5 billion in February, according to S&P LCD. This year $442 billion of the debt has been arranged, according to data compiled by Bloomberg.

Citigroup is raising the $395 million Apidos CLO VII, which is expected to include a $264.4 million piece rated AAA by S&P, according to two people with knowledge of the deal.

The Apidos fund may also include a $40 million AA piece, a $27.8 million A slice, a $16 million BBB piece and a $15 million BB slice, said the people, who declined to be identified because the terms are private. There is also $31.7 million of subordinated notes.

CLOs are a type of collateralized debt obligation that pool high-yield, high-risk loans and slice them into securities of varying risk and return.

QE3 Expectations

Economists have lowered their U.S. growth forecasts for the year to a median of 1.75 percent, down from 2.7 percent three months ago, according to data compiled by Bloomberg.

The European Central Bank began purchasing Spanish and Italian bonds on Aug. 8 to try to stabilize the debt markets in those countries as the credit crisis threatened to engulf more countries. The yield on Italian 10-year bonds rose to 6.195 percent Aug. 4 before sliding to 5.29 Aug. 8. The debt currently has a yield of 5.36 percent. Ten-year Spanish yields peaked at 6.32 percent July 18 and recently traded at 5.1 percent.

“QE3 expectations may be a window of opportunity for managers to claw back some lost performance, but the macro environment is still deteriorating both here and in Europe,” Garman wrote. “Unless they ‘‘go big’’ with QE3, the bid for risk may be short-lived.”

--Editors: Faris Khan, Chapin Wright

To contact the reporter on this story: Richard Bravo in New York at rbravo5@bloomberg.net.

To contact the editor responsible for this story: Faris Khan at fkhan33@bloomberg.net.


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