Flash Update: FT reports alarming rise in leveraged loans, especially Cove-Lite debt & PIK notes

This past Saturday (10/22/13) the Financial Times reported about the alarming rise in “cov-lite” loans in the leveraged loan market.  The Fed-induced  “ultra-low rates have made the loans for highly indebted companies white-hot in recent years as investors clamour for the higher yielding assets and corporates rush to refinance old debt.”  In 2013, the volume of leveraged loans written to date is on track to match or exceed the record set in 2007 just before the bursting of the credit bubble.  However, at the same time, the quantity of cov-lite loans within the leveraged loan market has actually doubled since 2007.

So the obvious question is: Has the underwriting quality kept pace even with 2007’s standards?  Do cov-lite corporate loans signal the next sub-prime debacle?  “Once the vast majority of leveraged loans are issued as cov-lite, few will be able to argue that only the strongest credits are getting the cov-lite treatment.  The trend has not gone unnoticed by regulators.” says the Financial Times. 

Yesterday’s Financial Times additionally reported that the issuance of payment-in-kind (PIK) toggle notes, allowing the company to pay lenders with more debt rather than cash, has surged in recent months.  There has been $9.2 B of PIK note issuance this year, already nearly 40% higher than last year and approaching 2008 levels.  32% of companies that issued PIK bonds during the bubble era defaulted at some point from 2008 to mid-2013, according to Moody’s. 

While cov-lite leveraged loans and PIK toggle notes may not in and of themselves represent the type of systemic risk to the economy as the sub-prime market, they could represent a significant trading opportunity and early warning sign for funds such as the Tradex Short-Biased High Yield Portfolio.

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global