U.S. junk market takes forced but manageable break

March 16, 2011

By Agnes T. Crane
The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

It was time for a breather anyway. Volatility is to blame for sub-investment grade companies like Toys R Us yanking more than $7 billion of issuance this week. But after a buoyant spell in the debt markets, the break is no disaster.

The confusion from the catastrophic events unfolding in Japan has forced investors across the globe to reassess risk. Those lending to high-yield companies should welcome the respite from the breakneck pace experienced for most of this year. Investors already had lent more than $140 billion in fresh funds to risky companies, with the once moribund leveraged loan market making up more than half the new deals.

The reach for yield, a powerful driver when the global economy is humming, threatened to whip up additional froth. Standard protections already were being sacrificed. So-called covenant-lite deals, which typified easy borrowing during the boom, comprised 16 percent of total leverage loan issuance this year, according to Thomson Reuters LPC. Volatile markets, though unpleasant, will give enthusiastic investors a much needed time-out to reassess whether such deals are really worth it.

Borrowers, meanwhile, are in good shape to weather a temporary shutdown. Over the last two years, companies have taken advantage of easy money that gets paid back much later. At the end of 2008, a wall of debt cast a long shadow over the market. More than $800 billion was scheduled to come due through 2014, according to Bank of America, which reckons it  will have shrunk to a mere quarter of that by the end of the year.

Toys R Us, for one, hardly looked desperate. A $500 million outstanding bond matures this year, but not until August. Moreover, the bulk of its $1.1 billion deal re-prices an existing loan that doesn’t mature until 2016, according to KDP Advisors.

A forced closing of any credit market will rightly unnerve all participants, who won’t have forgotten the paralysis induced by the subprime financial crisis. But borrowers and lenders are both in better shape to cope with the situation now. The pause might even help cool things down and recalibrate risk expectations when activity restarts.

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