Tag Archives: Leveraged Loans

Leveraged-Loan Risks Are Piling Up, by Wolf Richter

Yet another candidate for the sector of the debt market that gets the ball rolling on the next debt crisis. From Wolf Richter at wolfstreet.com:

Rising interest rates have a peculiar effect.

US junk-bond issuance in June plunged 31% from a year ago to just $14.5 billion, the lowest of any June in five years, according to LCD of S&P Global Market Intelligence. During the first half of the year, junk bond issuance dropped 23% from a year ago to $110.6 billion.

Is investor appetite for risky debt drying up? Have investors given up chasing yield? On the contrary! They’re chasing harder than before, but they’re chasing elsewhere in the junk-rated credit spectrum: leveraged loans.

Leveraged loans are another way by which junk-rated companies can raise money. These loans are arranged by banks and sold either as loans or as Collateralized Loan Obligation (CLOs) to other investors, such as pension funds or loan funds. They’re a $1 trillion market and trade like securities. But the SEC, which regulates securities, considers them loans and doesn’t regulate them. No one regulates them.

In the first half, companies issued $274 billion of non-amortizing leveraged loans, and $97 billion in revolving and amortizing leveraged loans, according to LCD, for a total of $371 billion, on par with the record set in the first half last year.

This is well over triple the amount of junk bonds issued in same period ($110 billion).

Many of these loans have floating interest rates, typically pegged to the dollar-Libor. And in an investment environment where the Fed has been trying to push up interest rates, Libor has surged, and floating-rate loans, whose interest payments increase as Libor ratchets higher, are very appealing to investors – despite the additional risks these higher interest payments pose for the companies that are already struggling with negative cash flows. LCD:

The U.S. leveraged loan market, which is accessed by speculative grade debt issuers, has been exceedingly hot over the past two years or so as investors pour money into the asset class in anticipation of rate hikes by the Fed. Such moves usually boost interest in floating rate asset classes.

Given the “sustained investor appetite” for this type of debt, companies have been able to issue these loans with lower spreads over Libor, making it cheaper for companies to borrow – until rates rise further. That’s when this debt gets more expensive for these companies that already have a high debt load, often combined with money-losing operations – the combination that gives them a non-investment grade or “junk” credit rating (my cheat-sheet on credit rating scales).

To continue reading: Leveraged-Loan Risks Are Piling Up

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When High-Risk Loans Blow Up, by Mike Larson

It’s not just bonds that are flashing red, so too is the leveraged loan market. From Mike Larson at moneyandmarkets.com:

Ever heard of the S&P/LSTA U.S. Leveraged Loan 100 Index? Probably not. But as an investor who cares about building or preserving wealth, you should definitely pay attention to the message it’s sending out.

To briefly explain: This index tracks the performance of 100 large, higher-risk, higher-yielding loans. They have a term of at least one year, are denominated in U.S. dollars and are issued on a senior secured basis.

These kinds of loans are typically used to finance leveraged buyouts, mergers and acquisitions or other corporate actions, all of which soar at the tail end of a credit cycle. They’re usually taken out by higher-risk companies with a lot of existing debt and lower credit ratings. As a result, they’re among the first loans to sour when the economy starts breaking down, credit conditions start tightening and easy money drains out of capital markets.

With that preamble out of the way, take a look at this chart of the index …

You can see that it topped out in mid-2014 — before the recent stock market struggles. You can also see it made a “lower high” in early 2015, and has done nothing but fall since then. As a matter of fact, it just hit the lowest level in more than three years.

To continue reading: When High-Risk Loans Blow Up

And Now Defaulted Leveraged Loans Go Kaboom, by Wolf Richter

And the debt deflation beat goes on. From Wolf Richter at wolfstreet.com:

“It’s been a rotten year for distressed and defaulted loan paper.” That’s how S&P Capital IQ LCD starts out its report on leveraged loans.

“Rotten” may be a euphemism. So far, 2015 has been the worst year for defaulted “leveraged loans” since 2008 when the US financial system imploded under its own excesses.

Leveraged loans are the loan-equivalent to junk bonds. They’re issued by junk-rated over-indebted companies often to fund M&A – such as the loans issued by junk-rated, over-indebted Valeant – or to pay a special dividend to the private equity firms that own the companies, which is a form of financial strip-mining. They’re an $800-billion market and trade like securities. But the SEC, which regulates securities, considers them loans and doesn’t regulate them. No one regulates them. This gives issuers and banks a lot of leeway.

Leveraged loans are too risky for banks to keep on their balance sheet. Instead, they sell them to loan mutual funds or ETFs so that they can be moved into conservative retirement portfolios, or they repackage them into Collateralized Loan Obligations (CLO) to sell them to institutional investors, such as mutual-fund companies.

But banks can get stuck with them when markets come out of their euphoria, as they did during the Financial Crisis. So the Fed and other regulators have been exhorting banks for two years to back off. With some success: issuance has started to decline.

The “reach for yield” over the past few years, in an environment where the Fed’s zero-interest-rate policies have repressed yield, has turned investors into blind daredevils, taking on huge risks for ludicrously low returns. This allowed companies to issue leveraged loans at very low interest rates and as “covenant-lite,” with few of the protections that investors demand during saner times.

Even the Fed has fretted about “reach for yield” in numerous statements. It’s one of the most efficient wealth transfer mechanisms known to mankind. Wall Street knows exactly how to use it.

To continue reading: And Now Defaulted Leveraged Loans Go Kaboom