InvestNow News – 14th Feb 20 – Harbour – Monitoring the US leveraged loan market
Investors have their noses to the wind for the source of the next crisis. The terrifyingly titled pile of debt, known as “leveraged loans”, could be starting to pong. At Harbour we remain vigilant, monitoring the US market, but taking comfort in the structure of markets down under.
Leveraged loans are simply private market borrowing by sub-investment grade companies[1]. The US leveraged loan marketplace provides well over $US1 trillion in funding for companies involved in private equity buy-outs, gearing their balance sheets or funding expansion. Banks provide around half of this funding with the remaining share going to institutional investors, hedge funds, insurance companies and non-bank finance companies[2]. Banks underpin support for a sizeable European market also; the New Zealand market is tiny in comparison. But we do have leveraged loans. For example, the debt funding used by a private equity firm to buy TradeMe is considered a leveraged loan.
Potential warning signs
In addition to accepting higher gearing levels from borrowers, lenders have increasingly permitted more aggressive accounting to weaken their covenants. For example, intangibles now make up a far greater percentage of assets in debt/asset ratios and management earnings adjustments, baking in yet-to-be realised earnings, make up a significant portion of earnings in debt/EBITDA ratios. Worse still, the portion of loans with lax covenant packages, known as “cov-lite” loans, has soared as shown below.