Friday Letter: The bubble is leaking

They say the current correction in global equity markets has not had any significant impact on debt markets.

And they can roll out research from Standard & Poor’s credit team to support the claim that it is business as usual. Anne-Charlotte Pedersen, an analyst at the rating agency, said in a note on 27 June that issuance of senior secured bonds in the last quarter had continued to be significant, as borrowers took advantage of oversupply to negotiate tight pricing and minimal covenants.

So not only are the loans cheaper, but the terms are slacker than ever. And re-payment of loans is increasingly deferred. Pedersen noted that during the last quarter the size of non-amortising loan tranches had grown, and in several recent transactions that had begun to creep into the A tranche. For the more pessimistic investors this is storing up trouble for tomorrow.

Pederson, with a degree of understatement, said: “We will be interested to see to what extent recoveries will be affected by bond structures with multiple noteholders once a default occurs.” Not half as interested as the equity investors will be.

But there are signs that on all sides of the deal the ardour to invest at any price is abating. Privately bankers are saying they expect the crunch to come any time soon.

The latest numbers from data provider Dealogic suggest a more cautious approach than for almost half a decade. Sponsor-backed loan volumes were down 8 percent to $218.9 billion, the first decline since the first half of 2002.

Also telling was the flexibility JPMorgan, Deutsche Bank and Lehman Brothers demonstrated earlier this week on the pricing of the €1.25 billion financing for German Media Partners, the consortium owner of 50.5 percent of ProSiebenSat.1 – clearly a concession to investors who were no longer prepared to take any paper at any price. The banks responded to institutional investor concern that the risk-to-reward ratio on the deal was out of kilter by increasing the margin on the debt and cutting the term.

The bankers said it was a highly structured and innovative product and they were happy to compromise as part of “mutual education” process. But the fact remains that investors pushed back on a deal and the bankers moved to appease them by improving the deal. This is unusual in Europe.

It does not mean the market is slamming on the brakes. The buyout industry will probably set a few more records for leverage yet. The bankers will breathe deeply and press forward for fees. But a line has been drawn. Institutional appetite for debt can no longer be taken for granted.

The bubble has not burst, but it is leaking.