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Leveraged Loans Are Back to Pre-2007 Levels, and Could Quickly Surpass Them

Sept. 25, 2017 (EIRNS)—A Sept. 24 Wall Street Journal article sounds a nervous alarm on the rapid growth of lending to the most highly-indebted companies in the United States and Europe, which, investors worry, "could pressure financial markets if the global expansion starts to fade." Has the Journal figured out that the fading has already begun?

So far this year, volume in the United States for these leveraged loans is up 53%, which means it can easily surpass the 2007 record of $534 billion, according to S&P Global Market Intelligence’s Leveraged Commentary & Data (LCD) unit. Right before 2007, the boom in leveraged loans was one of the signs of a "overheated" market, as the Journal delicately puts it. But then, as the crisis intensified in 2008, investors in U.S. leveraged loans lost nearly 30%, reported the S&P/LSTA Leveraged Loan Index.

The Journal nervously remarks that while global growth is "picking up" and default levels are low, "the lending boom could prove troublesome when market conditions change or the economy slows." It feels like the market "is getting frothy," quoth Henrik Johnsson, the co-head of Deutsche Bank AG’s global debt-capital markets. "We’re overdue a correction."

The way this phenomenon plays out in Europe, is that recent loans offer fewer investor safeguards than in the past; hence this year, 70% of the region’s new leveraged loans are what are known as "covenant-lite"—meaning they impose fewer restrictions on the borrowers’ debt service capabilities—which is more than triple the number four years ago. In its recent quarterly report, the Bank for International Settlements, took special note of the proliferation of "cov-lite" loans, and warned that U.S. companies are more leveraged than at any time since the beginning of the millennium. Its understated conclusion was that in the event of a "downturn" or increased interest rate, this could "harm the economy."

A few facts worth noting:

Private-equity firms have long favored the leveraged loan market, in order to raise cash to finance company takeovers. But today, the Journal explains, investors are jumping in because quantitative easing has pushed down returns across bond and equity markets. Just in the United States, investors have poured $16.9 billion into loan funds this year, bringing total assets to $141.2 billion by the end of August, Thomson Reuters Lipper reports. Loans issued in the United States to fund leveraged buyouts from private-equity companies so far this year total $88.5 billion, up 74% from the same period of 2016, and on track to become the largest amount since 2007.

In the United States, nearly one-third of loans to private-equity- backed companies are leveraged six times or more, according to LCD. And this is despite 2013 guidelines from U.S. regulators, including the Federal Reserve, on loan underwriting, warning that leverage of more than six times "raises concerns for most industries."