Corporate America is feeling the impact of the slowdown in the $1.4tn junk-rated loans market on Wall Street. A growing number of companies are either paying higher costs or abandoning borrowing plans. This is due to changes in the market for collateralised loan obligations (CLOs), which are investment vehicles that hold about two-thirds of low-rated US corporate loans. For example, California utility PG&E had to shelve a loan extension, and Heartland Dental and Internet Brands had to pay higher interest rates or agree to stricter investor protections to extend loan maturities. These shifts have limited financing options for lower-rated borrowers and increased borrowing costs for many US companies.
Rob Zable, the global head of Blackstone’s liquid credit strategies, stated that finding new lenders impacts the cost of capital because new lenders require attractive terms. Over the past decade, leveraged loans have become a vital funding source for US companies and private equity groups, as traditional bank lending has decreased since the financial crisis. CLOs purchase various loans, package them, and use the interest payments to create new debt, which is sold to banks, insurers, and other investors.
However, CLOs are subject to rules regarding their “reinvestment period”. During this period, CLOs can use the revenues generated to invest in new debt. Once the reinvestment period ends, the funds must be used to pay down obligations. Pratik Gupta, a strategist from Bank of America, predicts that around 40% of CLOs will exit their reinvestment periods by the end of the year, reducing demand for new loans. Additionally, many CLOs have reached their limits on purchasing triple C loans, the lowest credit rating assigned by major agencies.
Furthermore, some CLOs are becoming increasingly concerned about the low-rated debt they already hold due to rising interest rates and their impact on the broader economy. The US Federal Reserve has signaled further interest rate hikes, which are expected to affect corporate profit margins and revenue growth. CLO managers are more hesitant to purchase risky loans, as rating agencies predict an increase in corporate defaults. The effects of failures of institutions like Silicon Valley Bank and Signature Bank have also caused ripple effects in the market.
According to some investors, the market’s challenges will lead to higher borrowing costs until demand for new CLOs increases. As an alternative to the CLO market, companies are turning to fixed-rate debt through high-yield bonds or opting for shorter-maturity loans. For instance, Heartland Dental repaid a portion of a loan set to mature in April 2025 by raising funds through the bond market and obtaining capital from its owners, KKR and the Ontario Teachers’ Pension Plan. However, to extend the maturity of the remaining loan, they had to increase the interest rate by up to 1.25 percentage points. Heartland, PG&E, and Internet Brands did not comment on the matter.
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