Credit Markets Will Enjoy One Last Hurrah

Riskier borrowers are going to enjoy one last hurrah in 2018. Chief executives and buyout firms will be more adventurous in a year of buoyant global growth. And they will be keen to lock in cheap borrowing costs before central bank policy becomes less generous. But the cheer may not last all year. A pickup in economic activity has yet to translate into a frenzy of risky financing.
The value of mergers and acquisitions worldwide fell 4% in the year to November, according to Thomson Reuters data. However, deals backed by private equity funds rose 32%, and the coming year should be friskier. Several large buyouts are already in the works in Europe, including the sale of Unilever’s spreads business to KKR and a spinoff of Akzo Nobel’s specialty chemicals unit.
Private equity firms have good reasons to invest. They have nearly $1 trillion of unspent capital, according to Preqin, and will be happier cooking up bold business plans in 2018, when the global economy will grow by 3.4% compared with 3.2% the year before, according to Citigroup.
(Preqin is the alternative assets industry’s leading source of data and intelligence, covering private equity, hedge funds, real estate, infrastructure and private debt.)
And bond and loan investors will continue to provide funds cheaply. Policy rates are low and the total amount of assets that central banks are purchasing will only be pared back slowly.
The European Central Bank will grow its balance sheet until at least September. Its policy of buying an average of €7 billion ($8.40 billion) of investment-grade company debt per month forces investors to pile into riskier junk bonds. There’s nothing to dim the attraction of such debt for now since Fitch Ratings expects the default rate in the US high-yield bond market to fall to 2% in 2018, below the 2.3% average outside of recessions.
But the risks are growing. The average debt to EBITDA (earnings before interest, taxes, depreciation and amortization) multiple on senior-ranking leveraged buyout loans in 2017 was 4.6 times, in line with the last peak in 2007, according to LCD, a unit of S&P Global Market Intelligence. And company executives are growing bolder: take Hochtief’s bid for Abertis, which would push the construction firm’s debt to over five times its EBITDA.
Faster economic growth could also prompt central banks to raise rates and shrink their balance sheets more quickly than anticipated. That could make 2018 a year full of surprises.