It’s crucial for the long-term health of leveraged loans, which have already surpassed junk bonds in magnitude, to allow investors to be more discerning. One of the most appealing parts of loans is that they’re supposed to have priority over traditional securities. But as Bloomberg News’s Sally Bakewell and Kelsey Butler wrote last week, heavily levered companies have been tapping the loan market over and over again, securing $100 billion of so-called incremental debt this year because money managers were willing to acquiesce to almost all issuers’ demands. On top of that, a larger share of companies have loans as their only form of debt, which doesn’t do lenders any good if they go under.
It’s pretty obvious that this sort of behavior won’t end well. That’s why it might be a blessing in disguise that the market has taken a breather. “There’s no need to chase new issues,” Michael Nechamkin, co-chief investment officer at Octagon Credit Investors, told Butler and Jeannine Amodeo. The ones who pull back, they note, are those that aren’t desperate for financing but were hoping to lock in cheap borrowing costs in the once-hot market. As for those who can’t afford to drop out? They pay up — restoring some balance between buyers and sellers.
With over $7 trillion in negative yielding debt investors have been willing to forgo covenants to capture yield. That has been most acutely evident in the leveraged loan market where corporations have been binging on debt in order to fund buybacks and pay dividends. The logic goes that will reduce the weighted average cost of capital and therefore strengthen the balance sheet. However, that only works as long as business is going well. In times of stress dividends can be cancelled but loans need to be paid back which can be a problem when liquidity is tight.Click HERE to subscribe to Fuller Treacy Money Back to top