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Robin Wigglesworth @RobinWigg
, 9 tweets, 3 min read Read on Twitter
The leveraged loan boom is storing up some nasty, nasty problems.…
To hammer the point home, here are some charts. Here's one that shows how the leveraged loan market has exploded even as the covenants have weakened.
How much have they weakened? According to Moody's index of their quality, loan covenants are at their weakest level since at least 2014, when this index began.
In fact, while Moody's index only goes to 2014, covenants are weaker on every measure than they were on the eve of the financial crisis in 2007.
The average ratings are also considerably worse. Before crisis, only 25% of loans were cov-lite and they were overwhelmingly stronger borrowers. Today, almost 80% of entire market is cov-lite, and the average rating has fallen by several notches.
That's why Moody's last week slashed its forecasts on expected recoveries from future defaults. From 77 cents on the dollar on first lien loans to 61 cents. For second lien loans the average recoveries could be as low as 14 cents, down from 43 cents historically.
Another big factor to consider is how leveraged loans have largely disappeared from bank balance sheets. That's great from a financial stability angle, but a lot has migrated into funds that offer daily liquidity - despite loans being generally awful to trade.
Here is one of my favourite charts. The number of mutual funds and ETFs that invest in loans has exploded in recent years, almost trebling since the financial crisis.
I don't think this is systemic. It's just something that will result in a lot of painful, embarrassing losses at some point. But I do worry about retail investors that have piled in on the facile promise that they'd make a bundle when interest rates go up. Fin.
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