Get Ready for Warning Signs in the Leveraged Loan Market

Leveraged loans, very much like subprime mortgages, aren’t a problem, until they become one.

We’re not there yet with leveraged loans, which are above-market interest loans made to companies with less than investment-grade credit ratings, but warning signs in the distance are intensifying.

Here’s what’s going on that you can’t see, why this huge pile of debt is a problem, what could happen, and how you can profit from what’s coming…

What Are Leveraged Loans?

Leverage, generally, is the use of something to maximize your advantage. For example, in business, a company can use borrowed capital to buy more inventory, to acquire additional assets, expecting profits from capital investments to exceed interest costs. In finance, leverage is the ratio of a company’s loan capital (debt) to the value of its equity, or common stock.

Leveraged loans are loans made to companies who are leveraged, meaning they’ve got debt on their balance sheet already, their credit rating is below investment-grade – even junk status – and the interest being charged reflects the higher risk of lending to an already leveraged company.

The borrowed money is used to finance private-equity transactions, or, for M&A deals, for leveraged buyouts, to refinance existing debt or recapitalize a balance sheet, and in hundreds of cases as lifeblood for cash-strapped companies.

Size matters.

In late 2018, the total leveraged loan market exceeded the high-yield bond market.

After plunging during the financial crisis, leveraged loans started making a comeback in 2011.

By 2013, issuance jumped to $607 billion. And, loans, in the last two years, surged beyond levels seen in the 2007-2008 financial crisis.

The market hit a record of $1.66 trillion in 2017 and stood at $1.46 trillion in 2018, according to data from Dealogic.

Demand is high.

There’s no problem getting leveraged, high interest loans for the companies lined up at the easy money trough, thanks to investor demand for huge chunks of packages of loans.

Because interest rates have been artificially tamped down for years, investors who want yield have to go further out on the risk spectrum to get any. That’s where leveraged loans are plentiful.

Banks and non-bank lenders make leveraged loans and package them into collateralized debt obligations (or CDOs; remember them from the financial crisis?), which investors have been gobbling up.

When investors buy packaged leveraged loan CDOs, the money they spend goes back to the originators of the loans, who to make more fees lending to more borrowers and more money packaging and selling more CDOs.

That’s why there’s plenty of money available for already leveraged-up companies.

Covenant-lite is easy to digest, until it isn’t.

With all the money being thrown at leveraged companies they’ve been pushing back on the debt covenants typically demanded by lenders.

Covenants in bond and loan indentures are the paperwork that defines the lender-borrower relationship. They offer protection to lenders by making borrowers abide by things like interest rate coverage ratios, leverage ratios, and what the position a lender has in the company’s capital structure.

But, with so much money being thrown at borrowers, they’ve pushed back on what covenants they’ll offer. Sometimes, they’ll say no to even the most basic protections.

Issues that don’t offer typical protections are called covenant-lite. And they’re everywhere.

In fact, because demand for leveraged loan investments is so high, and borrowers are in control of what protections they’ll offer, 80% of all leveraged loans made in 2018 were covenant-lite.

[URGENT] Make Up to $11,000 Every Week – Without Touching A Single Stock or Stock Option Again

Indigestion Often Follows Binge-Eating

Banks who hold these loans on their books are at risk, but so are investors such as pension funds, insurance companies and asset managers.

Besides economic hits and interest rate spikes upending the leveraged loan market, which I’ll get to, investors and the economy are more at risk because regulations are being whittled away.

Two years after the financial crisis, with companies in trouble and lenders starting to push leveraged loans for lucrative fees, issuance soared. And regulators saw flashing lights.

In 2011, the chief national bank examiner at the Office of the Comptroller of the Currency (OCC), Timothy Long, issued warnings to all examiners to be on the lookout for problems in banks’ leveraged loan books.

Further guidance was issued in 2013.

But now, that guidance is being watered down.

According to The Washington Post, “In October 2017, the GAO issued a report saying the 2013 ‘guidance’ should have been issued in a more formal way, a position that raised the possibility of invalidating the regulators’ power.”

The following November, Rep. Blaine Luetkemeyer (R-Mo.), then-chairman of the House subcommittee on financial institutions and consumer credit, sent a letter to the regulators asking for assurances that they would not be enforcing the leveraged-lending guidance.

The battle to reduce or eliminate protective guidance is probably heading to the Senate. That’s because “guidance” falls into an abyss of regulatory regimes, but a “rule” is definitive and is issued by a regulatory body with the power to enforce it.

By turning the “guidance” into a “rule,” a majority in the Senate can strike a rule issued by a regulator.

That’s what’s being worked on.

Already, official warnings are being sounded – if not loudly, at least distantly.

[CRUCIAL] You Could Be Entitled to a Monthly Amount of $2,084…or More!

Early Warning Signs

In an appendix to the latest federal budget unveiled in March, there was a not-so-subtle warning on these loans that read, “care must be taken that leverage doesn’t reprise the mistakes of the 2000s.”

The worry is that if interest rates spike, since leverage loans are mostly floating-rate loans, debt service costs will rise and a lot of borrowers may not be able to meet interest payments. Or, if the economy falls into recession, these leveraged companies won’t make enough revenue to pay interest and principal.

We might end up back reprising something like the subprime loan fiasco when who had leveraged up was exposed, meaning how leverage throughout the financial system had exploded as investors of all stripes bought and traded leveraged CDOs and related instruments and faced insolvency.

We’re nowhere near there, yet. But we could get there.

We’re looking at similar signals that were around on Black Tuesday in 1929 and Black Monday of 1987. It’s out of our hands, it’s up to the government to fix what went wrong.

And they could, but they won’t, which means it’s up to us to prepare for the worst. You still have a few weeks left to protect your family and your wealth. You’re going to want to see this

Speaking of the buildup in leveraged loans, former Federal Reserve chair Janet Yellen said in a recent interview, “This means that the next downturn that we have could be more serious and longer-lasting and more difficult to deal with than it would have been if we had constrained these practices.”

The warning lights are subtly flashing in the background of the economy.

I’ll tell you what’s about to happen and what you can do to profit from it on Friday.

Sincerely,


Shah

The post Get Ready for Warning Signs in the Leveraged Loan Market appeared first on Wall Street Insights & Indictments.

Powered by WPeMatico