May 1, 2019

What Investors Need to Know about the Growing Leveraged Loan Market

The leveraged loan market has grown significantly, becoming "covenant-lite" and increasing risks for lenders and investors.

Investors and lenders may be at heightened risk with the reduced covenants and skyrocketing number of leveraged loans.

The leveraged loan market has expanded dramatically over the past few years, possibly painting a risky potentially picture for investors and lenders.

It's been estimated that over $1.4 trillion worth of leveraged loans were outstanding by the end of 2018, and $736 billion worth was issued in the year.

Leveraged loans are loans that are provided to companies that already owe quite a bit of money. They're frequently used by private equity firms to take over companies through leveraged buyouts.

By the end of 2018, the overwhelming majority of leveraged loans - about 85 percent - did not meet the conventional criteria in place to protect the investors who fund them and were thus deemed covenant-lite. Compare that to 2011, when only 23 percent of leveraged loans were classified in the same category.

These "covenant-lite" loans, therefore, point to loans that could lead to lowered performance in the lending sphere. With a decline in underwriting standards - which was on full display back in the financial crisis over a decade earlier - the risk of increased delinquencies and defaults in the near future is quite possible.  

Lenders have been more open to issuing leveraged loans thanks to the relatively healthy returns they've been seeing. A high rate of interest due to the relatively high risk of failure and "floating" rates that require borrowers to pay more as rates increase can bring in sizeable returns for lenders. 

Borrowers have flocked to leveraged loans because most have fewer covenants that require borrowers to meet certain financial criteria in order to get approved. These loan types also provide some flexibility in terms of early repayment.

Demand for leveraged loans has increased significantly among investors looking for big yields as the Federal Reserve held rates at ultra-low levels for an extended period of time. Companies have benefited from this situation and increasingly issued covenant-lite loans.

By 2018, 85 percent of all leveraged loans were "covenant-lite" compared to just 23 percent in 2011.

But leveraged loans are risky. In fact, they're perhaps the riskiest form of corporate debt because they're leveraged against private equity groups' money and leveraged companies' ability to pay off all outstanding debt. And a lack of covenants robs the market of early warning signs if things going awry and can weaken transparency that would expose any issues with borrowers, thereby reducing protection among investors.

A lack of covenants fosters an environment whereby creditors won't be able to adequately intercept risky activities among companies, which can magnify risks for investors and increase their losses.

Considering that most leveraged loans lack the necessary lender-protecting financial requirements, now would be a good time for lenders to reassess their loan portfolios and consider selling riskier assets. Even if they must sell at a slight discount, the minimal cut they may experience is better than risking potentially larger losses in the future.

At Garnet Capital, we can help you accurately determine which assets are lowest performing and devise a strategy to help you sell such assets to make room for those that come with the least amount of risk.

Our team of seasoned loan Sale Advisors will guide you through the loan sale process to develop a customized strategy that will leave you with a stronger loan portfolio that will be better able to withstand any economic volatility.

Browse white papers today and see why you should partner with Garnet Capital today.