Leveraged Loans — The Debt Bomb You Need to Know About

Those who follow the market are aware US 10-year bond yields have been rising steadily since July 2016.

But what many people don’t know is that there is a hidden debt bomb that could blow up in the next two years — leveraged loans.

A leveraged loan is a debt instrument made by lending syndicates to non-investment grade companies.

Usually pegged to the three month LIBOR, they are sometimes considered a safe-haven from the rising interest rates we have discussed.

But in some ways they are like the pay-day loans of the business world.

If you want to worry about something — this is it

As the head of JP Morgan’s US$100 billion alternatives investment arm notes the leveraged loan market consists of:

Private entities, that buy and sell private, direct lending and debt to each other. Unregulated, generally. It’s a shadow market. I would argue it’s a shadow banking market.

He goes on to ominously say that:

If you want to worry about something in the next two or three years, this is it. 

Just like the sub-prime mortgage crisis of 2008 that set off the GFC, loosening of regulation is partly to blame.

If you believe a recession is on the cards, check out our Aussie Recession Survival Guide. Download your free copy here.

The terms of the loans are set out in something called a covenant which stipulates what the borrower must do to preserve the interest of the loan.

This could include things like leverage ratios.

Leveraged loans put global recession on the cards

But increasingly, these covenants have been weakened to allow for more lending to take place.

More than 80% of new loans are now characterised as ‘covenant lite’.

This insidious debt bomb has now reached upwards of $1.36 billion in value.

U.S. leveraged loan issuance 2011-2017

Source: Bloomberg.com

 

As the Bank of England recently warned:

The global leveraged loan market was larger than — and was growing as quickly as — the US sub-prime mortgage market had been in 2006.

And below we have a chart that maps out the risk of recession over different periods of time:

Recession probability

Source: bloomberg.com

Things are starting to look pretty bad indeed.

It could be the leveraged loan market that sets it all off.

Regards,

Ryan Clarkson-Ledward,
For 
Markets & Money

PS: If you think markets are set for a major contraction, have a look at our free report on how to protect your wealth in a fast-shrinking economy.


Ryan Clarkson-Ledward is a junior analyst for Markets & Money. Ryan has degrees in both communication and international business. His priority is bringing you the latest price updates on stocks through ASX updates, as well as supporting Sam Volkering with background research. As part of the team at Markets & Money his aim is to provide unbiased and relevant news for readers. Ryan’s work with Sam is designed to provide research that complements Sam’s analysis for small-cap and technology stocks. Together, their objective is to break through all the jargon and give you the hard facts to inform your investment decision-making. Ryan writes for:


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