A feeling of unease is beginning to steal over the leveraged finance market. Like that point on the ski slope when you start to go just a touch faster than you’re entirely comfortable with.
What if I encounter a tree over the next horizon? You ponder nervously. Would any market participants actually admit to this creeping unease, or do they plan to keep skiing on regardless?
The numbers are impressive. Theres been $371bn worth of leveraged loan issuance in the US in the first half of this year, according to S&P. Up 70% on the equivalent period in 2016. And, in Europe, total leveraged finance volumes reached a record $143bn in the first half of 2017 up almost 8% on the entire of 2016, according to Moodys.
That is some velocity. Are we really in control? Regulators in the EU, if not the US, are nervous. In Europe, moves have been made to curb rising leverage levels though some argue this has only acted to increase average leverage, as issuers rush to complete deals before the ECBs guidelines come into force in November. These guidelines were designed to ape guidelines already in place in the US but which the US backed by a Trumphantine exuberance - is now seeking to relax (good luck getting that through Congress, Donald).
Covenant (de) light for issuers
So, in short: more money is chasing fewer deals, pricing is plummeting, credit quality is on the wane and useful precautions, like covenants, have been sacrificed as lenders scrabble to win deals. According to S&P, the number of single B issuers in other words junk has risen substantially. In the US, so-called covenant light loans now make up 70% of the total outstanding loans, say S&P. This is the highest ever. More worryingly, in my opinion, is the increased complexity of deals. As we learnt to our severe detriment 10 years ago the less people understand, the more likely a crisis becomes.
And this boom in leveraged finance shows no sign of abating. According to Hanna Zhang, Associate Director for US Recovery Ratings at S&P, its going to remain busy. Why? She points to the prospect of rising rates, continued benign credit conditions, a history of recent positive performance and, in the US at least, talk of a scaling back of the leverage guidelines.
Somethings got to give
It all feels very 2007-ish. Its certainly exuberant out there, but is it irrational? Should we be worried? The answer from most Ive spoken to is, not yet. Underlying credit quality is still holding (apparently) and the two most important gauges for risk, the leverage ratio and the interest coverage ratio are, I am told, largely unchanged over the last year. But now is not the time for complacency. The market is beginning to resemble my skiing. Fast, fun and just a little bit out of control. Lets hope there are no large fir trees hidden behind the horizon.
We are looking forward to discussing the outlook for the leveraged finance market at The GlobalCapital Leveraged Finance Conference in London on Tuesday 14th November. For more information, please visit the event webpage.
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