Blackstone Group LP filled a Tokyo ballroom earlier this month with locals seeking riskier U.S. loans as regulators in New York try and avert a credit bubble.
The money manager’s seeking to bring more Japanese investors into North American credit markets as one of its senior executives predicts gains as high as 6 percent and as local sovereign yields languish near zero. In the U.S., efforts by regulators to limit froth in the $830 billion speculative-grade loan market are gaining traction, as ultra-low interest rates fuel demand for high-risk assets.
“If you’re sitting here in Japan, and you need an alternative to JGBs to pick up some return, where are you going to go?” Daniel Smith, a senior managing director at Blackstone’s GSO Capital Partners LP unit in New York, said in an interview. “You can go to emerging markets, but those look quite risky to us, so by process of elimination, U.S. credit markets are a relatively easy and sober choice.”
GSO is seeking to grow its Japan business, which accounts for about 8 to 10 percent of the unit’s $73 billion of assets under management, according to Smith. The Bank of Japan’s unprecedented monetary stimulus pushed yields on the nation’s 10-year government bond to 0.195 percent last month, making riskier overseas debt all the more attractive.
In November, Wall Street’s biggest lenders were summoned by U.S. banking regulators to another ballroom half a world away in New York’s Pierre hotel. The message? Stop arranging risky corporate loans that are inflating another credit bubble, or potentially face fines or suspensions, according to people familiar with the matter.
The warnings may be working. Debt levels for companies funding buyouts in the leveraged-loan market fell in the fourth quarter for only the second time since 2012, Standard & Poor’s Capital IQ data show. The crackdown may cut loan issuance by as much as $80 billion in 2015, according to Bank of America Corp.
“We select all the loans we invest in based on rigorous fundamental credit analysis,” said Smith. “Some of these six times leveraged transactions are actually good credits and some are not. Our investors hire us to select the best ones.”
Since 1998, the company’s average annual loss due to loan defaults is 21 basis points, compared with a market average of about 121 basis points, according to Smith. More than 200 people including investors attended Blackstone’s Tokyo seminar.
The Federal Reserve signaled last week it may keep interest rates near zero for longer, surprising investors who expected an increase as early as June. The central bank cited risks ranging from a stronger dollar to the Greek crisis, according to minutes of its Jan. 27-28 meeting released Wednesday in Washington. Most Fed officials still expect to raise rates this year.
U.S. high-yield bonds returned 2.5 percent last year, the lowest since the financial crisis and down from 7.4 percent a year earlier, Bank of America Merrill Lynch indexes show. That compared with a 7.3 percent gain on corporate debt rated single A or higher, up from a 1.9 percent loss in 2013.
When it comes to high-yield loans, Japanese fixed income investors are primarily interested in credits at the BB area, just below investment grade, according to Smith. Returns last year were about 2 percent as loan funds experienced outflows, causing prices to fall, he said. The asset class may see price appreciation this year with returns of 4 to 6 percent, he said.
“Japanese investors need to examine for themselves the credit quality of what is in these U.S. loan funds,” said Yusuke Ueda, a credit analyst at Bank of America Merrill Lynch in Tokyo. Funds seeking returns of 4 to 5 percent may need to add loans of companies further down the junk scale, rated from B to CCC, he said.
U.S. regulators finalized a rule in October requiring managers such as GSO that bundle high-yield corporate loans as collateralized loan obligations to hold at least 5 percent of the deals they arrange, starting from 2016. The rule is intended to ensure investment firms and banks are on the hook for at least a portion of their deals’ risk.
Trades of speculative-grade loans climbed 21 percent to a record $628 billion last year, surpassing the previous single-year high established at the onset of the financial crisis in 2007, according to the Loan Syndications and Trading Association.
Average yields on U.S. speculative-grade notes sold by companies have fallen 45 basis points this year to 6.5 percent after sinking to a record low 5.7 percent in June.
The U.S. credit cycle is still at a point where Smith isn’t worried about a “big sustained” uptick in defaults, making secured corporate loans attractive.
“The financial crisis in 2008-09 rinsed so much risk out of the system that the current cycle was started from a very low base,” he said. “You still have mainly green shoots at this point.”
That doesn’t mean there aren’t valuation risks or that some industries such as energy won’t face bumps following the fall in commodity prices, he said. Oil’s sharp decline is a big plus for credit markets generally, he said.
“All these people and companies all over the world will have more discretionary dollars, and that takes time to play out,” he said. “It’s a massive quantitative easing if you think about it because you put the money directly in the pockets of the consumers and businesses.”
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