The riskiest tranche of junior loans amounts to $3.3bn, almost double the amount raised at the same stage last year and the most over the same period since 2007
Dow Jones/London
Investors are gobbling up some of the riskiest debt from junk-rated European companies at the fastest pace in years.
Companies with lower credit ratings have raised $186bn in junk loans so far this year, according to Dealogic. The riskiest tranche of that debt-so-called second-lien, or junior, loans-amounts to $3.3bn, almost double the amount raised at the same stage last year and the most over the same period since 2007.
The rise in junior-loan issuance comes as loose monetary policy from central banks has depressed yields, pushing some investors into riskier assets that offer higher yields.
If a borrower goes bust, junior lenders are only repaid if some other, higher-ranking lenders, get all their money back. Only unsecured creditors and shareholders are further down the queue. Companies also get better terms-junior loans are less restrictive when it comes to taking on additional leverage than senior debt, while borrowers get more flexible repayment options than bonds.
In exchange for the additional risk, investors get a better return. Interest rates on junior loans are typically 3.5 percentage points higher than senior loans, bankers say. That has helped push total returns on European junior loans to 3.29% this year through last week, according to a Credit Suisse index. Senior loans have returned 1.85%. Total returns include price changes and interest payments.
“If you have more demand than supply then you end up with a loosening of terms and potentially more leverage and more aggressive structures,” said Elissa Johnson, a fund manager at Henderson Global Investors, which oversees around £1bn ($1.66bn) of loan assets.
Dealogic data show that more than half the loans that include junior debt have been used for acquisition financing, with a smaller proportion financing dividend payments.
Fiona Hagdrup, a fund manager at M&G Investments, which has more than €8bn ($10.6bn) invested in loans, says her firm has participated in a couple of junior deals where loans were being used for fresh acquisitions but none where cash was being returned to shareholders.
“We’d be a bit more sceptical about the investment merits of a second-lien issue for dividend purposes, but this time proceeds are going more towards genuine new buyouts,” she said.
Meanwhile deal sizes are getting larger too. Last month, Spanish private hospital operator IDCSalud raised €2.15bn in junk loans, €350mn of which was in junior debt, the largest junior deal from a European company in three years.
“We’re seeing more and more requests from companies for these type of deals,” said Hoby Buvat, a managing director for leveraged debt capital markets at Deutsche Bank. “We’re at the stage now where we’re testing the depth of this market.”
Losses on junior loans can be steep if a company fails. The average recovery rate on defaulted junior loans in Europe between 2003 and 2013 was 36%, according to Standard & Poor’s. That compares with 76% on senior loans, S&P data show.