Risks of unsafe business loans hit record high, says Moody’s
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Investors in the types of corporate debt that former Fed Chairman Janet Yellen warned about a month ago have never been so exposed, according to Moody’s Investors Service.
The quality of commitments, or the protections enjoyed by lenders, hit an all-time low in the third quarter, the most recent period for which data is available, according to an indicator used by the rating agency. The reading has come down to 4.16 on a scale that considers 1 the maximum protection and 5 the minimum.
“Lenders are at greater risk than ever before,” said Derek Gluckman, senior covenants manager at Moody’s, in a research note with Others. “Once again, our scores reflect weaker year-over-year protections in almost all of the risk categories we assess. Given the breadth and depth of weak covenants, existing loans are in uncharted territory.
Leverage loans are given to businesses that already have high levels of debt relative to capital and often have low credit. So they’re already risky, and the lack of strict commitments makes it even more so.
At a conference in December in New York, Yellen compared the current situation with leveraged loans the risky behavior that helped provoke the financial crisis. She said the debt is bundled into packages called secured loan bonds which are then sold to investors looking for yield.
“Corporate debt is now quite high, and I think there is a danger that if there is something else causing a slowdown, these high levels of corporate debt could prolong the slowdown and lead to further downturns. numerous bankruptcies in the non-financial business sector, “said the former head of the central bank.
Leverage loans have become increasingly popular in recent years, and their total outstanding amount has now exceeded the junk bond market by $ 1.2 trillion, Moody’s reported.
The agency said yield-hungry investors were willing to tolerate looser protections to the point that they are now weaker than they were even before the onset of the financial crisis in 2008. Much of this money comes from the institutional side. The exchange-traded funds that track the lending market hold more than $ 8 billion in assets, although the largest, the $ 5.3 billion Invesco Senior Loan fund, has seen about 30 percent of its assets redeemed over the past year.
“The breadth and depth of this weakness presents risks never before encountered by investors in leveraged loans, and the results under these extreme conditions have never been fully tested over a full market cycle,” said Gluckman.
Yellen isn’t the only one to warn of the dangers.
Billionaire hedge fund manager Seth Klarman of the Baupost group told clients in his latest letter to investors that heavily indebted companies will pose a significant danger if the economy weakens, which he says will happen soon due in part to levels of government and corporate debt.
“Higher interest rates will weigh significantly on today’s highly leveraged issuers, and the challenges will escalate when the next economic downturn hits,” wrote Klarman, who many see as inheriting the mantle of Warren Buffett as a market sage.
Regarding the specific threats due to the absence of restrictive covenants, Moody’s cites the monitoring of guarantees, guarantees and priority of privileges as the main issues. The agency said some lenders have taken advantage of weak protections to take on even greater risks.