For a number of years borrowers have been allowed unrestrained movement in the debt markets. This was largely due to huge demand from investors for high-yield products. The healthy profits and favourable market conditions helped companies to make their repayments and as a result, failure to pay was hardly an issue. This resulted in borrowers amounting huge pressure on banks to drop certain precautionary measures that they had adopted to protect themselves in the event of payment defaults.
At present however, investors are being very selective with their choice of investments. Lending institutions that had previously lent substantial amounts to finance huge deals, had done so on the premise of selling these loans on. A decrease in market demand has this week resulted in companies backtracking on two major deals due to close. Deals totaling $17 billion have been withdrawn in the past six weeks alone.
Many are citing the difficulties in the US subprime mortgage market as the principal cause of this change in behaviour. Here, defaults have increased vastly and have resulted in the downfall of several hedge funds. There have also been claims that failure to pay is a problem that has also spread to conventional loans in recent weeks, which is worrying as investors become nervous and tend to back away from investment commitments when even one area of their portfolio is experiences problems.
According to some ratings agencies, nearly $1 trillion has been raised in European credit markets in the first six months of this year and that there are a further $200 billion in deals currently in the pipeline. As a result of this, investors are seeking out higher yields. Credit default swaps spreads in the European high yield market are currently wide enough to cover the mean historic default rate. The US boasts an even higher level of spreads. If spreads are put under too much pressure however, this could cause significant flagging in the world economy. Corporate profits are also not exercising the same levels of growth that they have previously shown, which many banks will find worrying and may cause them to hold back before deciding to provide the funding for large deals in the future.