Leveraged/high-yield market prices have risen up drastically over the last 6 months, prompting questions on whether the industry is again building up some of the toxicity that caused the previous melt-down. Reports show that leveraged loan prices rose to as high as 92 cents on the dollar per the S&P U.S. Leveraged Loan 100 index, the highest level since late 2008.
Global high-yield debt sales has touched over USD 90 bn this year while US issuances have crossed USD 70+ bn, over 5 times 2009 levels for the same period. In line with high demand for leveraged loan issues, spreads have dropped to record lows, with below-CCC categories trading at just over 9 percent - as compared to the long term average of 12+ percent. Also, the trend has not been limited to issuers from specific sectors, but pretty much across the manufacturing and services spectrum.
Though the economy is definitely better placed now as compared to 2009, it is difficult to imagine that risks associated with the most risky borrowers have dropped that low, especially at this stage in the economic cycle...assuming there in fact is a correlation the market is placing between risk and return!
Just to prove a point, let's take a look at a another activity that is not directly tied, but driven by some of the same growth fundamentals - Leveraged Buy Outs (LBOs). LBO funds have raised the least capital over the latest period since 2004 and large funds including those from Caryle and Madison Dearborne have struggled to close LBO funds.
Average fund raising length for buyout funds seeking more than $1 billion is as high as 19 months now as compared to 16 months in 2009 and less than 5 months in 2004, per Bloomberg reports...deal closures have been even slower, resulting in firms sitting on massive piles of uncommitted capital. It is safe to argue that there is greater investor sophistication and 'better' due diligence that happens as part of LBO fund raising and deal closure as compared to traditional credit market activity. Also, given the fact that LBO deals arguably involve better reference credit as compared to that associated with high-yield issuers in the primary market, indicators from a tepid LBO market do not augur well for the high-yield credit market. Unless there is a perverse logic that issuers with the highest risk will see faster pick-up in activity during a period of weak economic growth! Just to clarify, I agree there is no direct correlation in the reference entities for credit in both cases (high-yield credit markets and LBO deals), but it should be the same fundamentals - economic growth and recovery prospects - that logically should underpin both markets.
Perhaps, capital market participants have extremely short memory spans - as this article on a recent BCG study points out, sliding revenues are possibly making profit-driven firms focus on the next stop for immediate super-profits...despite all the talk on risk-aligned performance measurement and deferred bonuses.