Corporate credit expected to tighten in 2019, but lenders not turning off the taps just yet

Corporate credit expected to tighten in 2019, but lenders not turning off the taps just yet

Businesses looking to borrow this year may find themselves facing a tougher credit climate amid an aging cycle and a recent investor exodus from loans to already indebted companies.

The Bank of Canada’s latest senior loan officer survey found that, while business lending conditions had eased, approval rates for Canadian corporate borrowers were lower in the fourth quarter of 2018, “because some respondents appear to be less willing to undertake deals with looser terms and conditions.”

Those deals included so-called “covenant-lite loans,” the central bank said on Dec. 21, such as ones that may have fewer restrictions around the payment terms or income levels.  

“Companies will continue to be able to access financing in 2019,” said Bill Wolfe, an analyst and senior vice president in the corporate finance group at Moody’s Investors Service. “It’ll just be a little bit tighter than it was in 2018 and 2017.”

Those tighter credit conditions could stem from higher interest rates or slower economic growth, with Moody’s saying in its outlook for North American, non-financial corporate borrowers for 2019 that “gradual monetary tightening will temper the cost and availability of credit.”

Corporate borrowers also watched reportedly record-breaking outflows from so-called “leveraged” loan funds in the United States to close out 2018.

Loans are dubbed “leveraged” when they are made to companies whose ratios of debt to assets or earnings are well above industry norms, according to blog post penned by International Monetary Fund staffers in November.

The loans are usually arranged by a syndicate of banks and issued to firms who already possess a significant amount of debt or weaker credit ratings, they added.

As of November, issuance of leveraged loans had hit an annual rate of US$745 billion, with the majority of the year’s total borrowed to help bankroll mergers and acquisitions, leveraged buyouts, dividends and share buybacks, the IMF staffers noted.

The borrowers are also spread across various sectors (albeit the bulk of the loans are tied to U.S. issuers), with most being from the technology, energy, telecom and health-care industries.

Leveraged loans have also become an area of interest for those watching for bubbles. The debts can be packaged into what are known as collateralized loan obligations (or CLOs), securities that bear a similarity to the collateralized debt obligations, stuffed with mortgages, that contributed to the global financial crisis a decade ago.

“A sharp rise in defaults could have a large negative impact on the real economy given the importance of leveraged loans as a source of corporate funding,” the IMF blog post said.

For borrowers, a concern would be if investor demand and lender interest in issuing the loans drop for a sustained period, or if borrowers struggle paying them back in a rising interest-rate environment.

Lisa Kwasnowski, a senior vice-president at DBRS, said they are keeping an eye out for any issues around the refinancing of leveraged loans, where a company would perhaps be unable to renew a loan or issue new debt.

“If we started to see that happen, maybe … becoming more common, we’d see that as a concern,” she said.

Wolfe said their sense is that the market is searching for “equilibrium” after a long period of low interest rates and quantitative easing that saw the U.S. Federal Reserve buy up securities at a steady clip.

“That asset allocation that unfolded from 2011 to 2016 is now reversing,” Wolfe added. “These funds that have had the benefit of these inflows for a long period of time, now they’re struggling to attract the same degree of funding that they’ve become accustomed to. And so … that’s how it affects these pools of capital that have supported leveraged loans.”

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