Just about all measures of investor complacency are flashing bright red. From Wolf Richter at wolfstreet.com:
Why? Wall Street sells “more financial products and generates more profits when investors are bullish.”
“Covenant-lite” loans – risky instruments issued by junk-rated borrowers, with few protections for creditors – set an all-time record at the end of the second quarter.
They’re part of the risky universe of “leveraged loans,” and they’re secured by some collateral, but they don’t come with the protections and restrictive maintenance requirements in their covenants that traditional leveraged loans offer creditors.
Even leveraged loans with more restrictive covenants are so risky that banks just arrange them and then try to off-load them to institutional investors, such as pension funds or loan funds. Or they slice and dice them and package them into Collateralized Loan Obligations (CLOs) and sell them to institutional investors. Leveraged loans trade like securities. But the SEC, which regulates securities, considers them loans and doesn’t regulate them. No one regulates them.
The amounts are not trivial. Total outstanding leveraged loans in the US reached nearly $1 trillion ($943 billion) at the end of the second quarter, according to S&P Capital IQ LCD. And covenant lite loans made up 72.5% of them, the highest proportion ever.
That’s up from 69% at the end of the fourth quarter. This chart shows the surge in the proportion of covenant-lite loans to total leveraged loans over the past three years, from about 55% at the end of Q2 in 2014 to 72.5% at the end of Q2 2017:
So what’s the big deal? When there is no default, there is no difference. And since there is apparently no longer any risk of default, it’s, well, no big deal. That’s what investors are thinking.
To continue reading: Risk has been Abolished, According to Institutional Investors