Leverage loans are exploding. Peaks in troubled corporate debt


This is the moment when the race for returns turns into a massacre.

Through Wolf Richter for LOUP STREET:

Leverage loans – they’re issued by over-leveraged companies rated rotten and with insufficient cash flow – are part of the gigantic pile of risky corporate debt that is being abruptly reassessed due to concerns about credit risk (the risk of default) are finally emerging. Since February 22, the S & P / LSTA US Leveraged Loan 100 Index, which tracks the prices of the largest leveraged loans, has plunged 20%:

The Index is another example of how, in these crazy times, when the most splendid bubble of all has collided with the coronavirus, more and more financial measures are violating the WOLF STREET beer mug saying that “Nothing goes to hell in a straight line.”

Leverage loans are risky and obscure. And that’s a big pile: about $ 1.2 trillion in US-sourced leveraged loans, up 50% from $ 800 billion in 2015. These loans are traded in installments like securities. or are bundled into highly rated collateralised loan bonds (CLOs). But for years, investors have had a crush on them, driven by their relentless pursuit of yield, in a world of interest rate suppression.

These companies are often owned by private equity firms that acquired them through LBOs, during which they loaded the companies with debt. In addition, private equity firms have extracted special dividends from their companies, funded by leveraged loans, which is a form of asset stripping. This leaves the business more in debt and more insecure and more likely to tip over. But who cares ? These were the good times and the hunt for yield was on.

The Fed, Bank of England, ECB, Bank of Japan, etc., they have all warned against leveraged lending. But they don’t regulate them because central banks aren’t securities regulators. And securities regulators, like the SEC, view them as loans, not securities, and they don’t regulate them either. And no one knows which balance sheets leveraged loans can dig into. But now they are making holes in the balance sheets.

Leverage loans that trade below 80 cents on the dollar are considered ‘distressed’ – and now 38% of leveraged loans trade below that distressed level, up from 10% on the 13th. March and 2% a year ago, according to LCD by S&P Global:

At the height of the 2008-2009 financial crisis, 81% of loans were priced below the 80 level. At the current rate of growth, the leveraged loan market will soon catch up. But as the LCD notes, the magnitude is different:

At the time, there were only $ 583 billion in leveraged loans outstanding; with 81% of them trading at distressed levels, there were $ 472 billion in distressed loans.

Today, there are approximately $ 1.2 trillion in leveraged loans outstanding; with 38% of them trading at distressed levels, there are $ 446 billion in distressed loans – almost the same as during the financial crisis 1, but we’re only weeks away.

And LCD reported that the average supply of the S & P / LSTA leveraged loan index had plunged to just 78.36 cents on the dollar at Friday’s close.

These are the 10 sectors struggling the most by the percentage of loans trading below 80 cents on the dollar at Friday’s close – and given the current mess, there aren’t many surprises on this list:

  1. Air transport (98%)
  2. Oil and gas (81%)
  3. Brick and mortar retailers (75%)
  4. Aeronautics and defense (69%)
  5. Leisure (68%)
  6. Hotels, motels, casinos (68%)
  7. Non-ferrous metals and minerals (62%)
  8. Automotive (58%)
  9. Chemicals, plastics (44%)
  10. Drinks and tobacco (43%)

And in the five trading days ended March 18, they are the biggest losers by sector, in terms of falling prices on their leveraged loans, according to ACL:

  1. Air transport: -15.4%
  2. Oil & Gas: -15.2%
  3. Accommodation & casinos -14.5%
  4. Cinema, Leisure, activities: -14.2%
  5. Non-ferrous metals and minerals: -14.2%

Companies whose loans are trading at distressed levels find it very difficult to borrow new money to meet their cash flow needs, pay interest and repay maturing debts. But these companies have insufficient cash flow to service their debts, which is one of the reasons they are first rated.

And when corporate debt explodes, it has an immediate impact on the real economy: at this point, these companies have to restructure their debts either in or out of bankruptcy court, which almost always leads to bankruptcy. layoffs, cost reductions and capital reductions. spending, which then spill over into the rest of the economy, accentuating the slowdown.

The Fed has highlighted this risk in its financial stability reports. But instead of alleviating the rampant race for returns and the corporate debt bubble by raising short-term rates to something like two percentage points above the inflation rate by 2015 and unloading the Stack of headlines off its balance sheet to evoke long-term rates, the Fed has further encouraged all of this with its loose monetary policies. So now it’s off again.

Angered by the sudden onset of the financial crisis 2, the Fed is rushing in all rescue directions. Read... Junk-Bond and BBB-Bond spreads explode beyond Lehman bankruptcy levels

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