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Late-Cycle Boom Stoking Investor Complacency in Institutional Loan Market, Report

July 19, 2018, 07:45 AM
Filed Under: Economic Commentary

Highly leveraged corporate borrowers are thriving in the current economic environment, according to a new report from Guggenheim Investments, the global asset management and investment advisory business of Guggenheim Partners. Earnings growth accelerated to 18% year over year in the first quarter 2018 for high-yield corporate bond issuers. Bank loan issuer earnings growth was also strong at 9%. Defaults have declined, leverage ratios have improved, and coverage is healthy.
The Federal Reserve’s confidence in the U.S. economy has sharpened in recent weeks. Nevertheless, geopolitical risk continues to weigh on the market, as positive headlines are offset by the trade war launched by the United States.
The late-cycle fiscal boost is stoking more investor complacency in the institutional loan market. Recent primary market trends are reminiscent of 2006 and 2007 activity, when heavy activity related to mergers, acquisitions (M&A) and leveraged buyouts (LBO) preceded the financial crisis.
Higher M&A and LBO volume is typically accompanied by higher leverage multiples. An increasing share of loans are being issued with six-times or greater leverage multiples, adding risk to a market that for the first time may experience a credit cycle turn without much covenant protection.
"Although we are not seeing the same level of M&A and LBO activity in the high-yield corporate bond market, it is not entirely immune due to M&A volume in the investment-grade corporate debt market," Guggenheim noted. "Fallen angels may create price dislocations in the future. Given little dispersion in pricing, increasingly similar credit profiles, and a convergence in covenant protection between the high-yield and the bank loan markets, we believe opportunities are beginning to look equally attractive in both sectors, but this remains a credit-picker's market."

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