Among the doom and gloom that has settled over the debt markets in recent weeks, a few beams of light are starting to break through.
In a briefing note, Augusta accepted that the credit cycle seems to have taken a turn for the worse, but suggested that talk of an imminent credit crunch was highly premature. “Temporary and readily identifiable factors” were responsible for most of the recent issues, the bank argued – specifically “indigestion” caused by the number of deals left in the pipeline as the market entered the holiday season.
“Talk of a credit crunch is absolutely exaggerated,” says Menzel. “This is not as it was in 1991, nor after 9/11 or in 1998 after the Russian default, when the market shut down completely for several months. This is an indigestion-led correction.”
The bank believes that the problems in the sub-prime market had a knock-on effect on other risky asset classes, which was then exacerbated by this bad timing, and exaggerated by market participants who had a vested interest in talking up the riskiness of the market.
“It’s in the interests of the underwriter to make a song and dance about how difficult the market is,” Menzel said. “The more risk they seem to be taking, the more they can charge.”
The number of pulled deals is not surprising, he believes, because in this kind of environment it is sometimes better to walk away. “Selling credit risk is all about confidence. There is no point in trying to sell a monster deal everyone is shooting at in a down market. Better to pull it, sit on it and so express your confidence in the credit. Let it season, and wait for the market to recover.”
But while the recent jitters have created volatility and caused loan spreads to widen, they haven’t brought the market to a standstill, Menzel says. “Even hairy deals are still getting done. Investors are still selectively buying – even among the credit funds, banks, CLOs… Some of the very-leveraged hedge funds and several non-specialists have retreated. But there’s still new money coming into the market.”
And the typical buyers of leveraged debt are still keen to buy, he adds. “Lots of hedge funds are talking a lot about how terrible the market is, but when they want the asset, they are only marginally bidding back from the earlier levels, if at all.
Although some of the big bulge bracket banks have stopped issuing debt while they work through their pipeline, this is no more than a temporary state of affairs, he argues. “The traditional lending banks have not made their budgets yet, so they won’t stop lending – not until their central credit committee tell them to stop, and we do not expect that to happen anytime soon as there’s nothing on the horizon to spook them.
As a result, reports of the demise of the leveraged buyout market have been greatly exaggerated, he suggests. “There are buyouts getting into trouble, and we are seeing more restructuring work. But it’s not a wave yet. Nor is that likely to change any time soon – there’s not a big enough catalyst out there, as far as we can see, that would occasion a jump in defaults. The environment remains benign – we’re seeing issues that are more technical than fundamental.”
In short, there is no need for the market to panic, he believes. “Yes, some of the really risky stuff – equity bridges, PIK toggles etc – is now off the agenda, and yes, we have probably seen a turn in the cycle. But solid, mid-market credits, that are not over-leveraged, are being sold into the present market.”