While the world’s banks are the largest holders of leveraged loans and collateralised loan obligations, new data has revealed about 40 per cent of these instruments are owned by asset managers, private equity, and hedge funds.
In its latest report, the International Institute of Finance pointed out institutional investors may have “significant exposure” via collateralised loan obligations (CLOs).
The IIF said trouble continues to brew as total US corporate debt climbs to US$15.5 trillion, which is 74 per cent of US GDP. To that end, the global capital flow tracker has issued an amber warning for the US corporate sector saying debt has been growing above trend, fuelled by an increase in bank lending “adding to worries about vulnerabilities in the corporate sector.”
According to the IIF analysts, of that US$15 trillion, fully one-third is made up of leveraged loans and junk bonds which is concerning since company defaults are expected to rise and bankruptcies have been climbing.
This topic will be covered at length by Danielle DiMartino Booth, chief executive of Quill Intelligence and a former Dallas Federal Reserve Bank adviser, at Investment Magazine’s Fixed Income and Credit Forum on August 27-28.
DiMartino Booth says the US capital markets are flush with triple-B debt that should, but isn’t, being downgraded by the ratings agencies.
“It’s very problematic,” she warned. “The rating agencies should have downgraded a good one-third of these bonds to junk at this point but they are holding the line and giving them a stamp of approval.”
In its latest report, the IIF noted global leveraged loan issuance fell to US$280 billion in first half of 2019, some 55 per cent lower than the year ago same period, due mainly to a big drop in covenant-lite issuance.
“Expectations of lower global rates have been a big factor in the decline, given that that leveraged loans are generally floating rate. While over 20 per cent of global issuance in the first half has been to refinance existing debt, almost half of leveraged loan proceeds was used to finance M&A and LBO transactions—a significant increase from 25 per cent a year ago.”
However, despite the marked slowdown in issuance this year, the Washington-based think-tank warned that leveraged loans have been the fastest growing segment of US corporate debt since early 2017, now accounting for over 10 per cent of large US non-bank corporate total debt.
“We estimate that over US$740 billion of leveraged loans come due through end-2020, with US dollar redemptions accounting for 85 per cent of that amount,’ IIF analysts claimed.
New Bank of England data suggests that banks, especially US ones, are the largest owners of leveraged loans and collateralized loan obligations (CLOs) with 55 per cent.
Across non-bank investors, hedge funds (11 per cent of the total), open-ended funds (9 per cent) and insurers (8 per cent) are the biggest holders.
What’s worse, the IIF warns, institutional investor exposures to leveraged loans could be larger than suggested by UK central bank: for instance, in recent years CLOs have played a key role in the robust growth of leveraged loans, and are now around 25 per cent of the market.
“While data on CLOs holdings are limited, insurers and other institutional investors could well be exposed to significant risk.”
Estimates by the National Association of Insurance Commissioners suggest that over US$120 billion of CLOs are held by US insurers, with life insurers accounting for 77 per cent of that. Similarly, a new US Federal Reserve Bank study suggests most Cayman-issued US CLOs (over 75 per cent of the US CLO market) are held by US investors, with holdings concentrated in insurers, mutual funds, and banks.
The Fixed Income and Credit Forum will be held at the RACV Healesville Country Club, VIC on August 27-28. Registration is open to institutional investors, chairs of investment committees and specialist consultants. Be sure to register here.
