Leveraged Loans

A dark corner of the financial market springs to life. Money piles in. Prices surge. Small investors clamor for a piece of the action. In the frenzy, risks are pushed aside. We've seen this movie before, and the later scenes usually aren’t pretty. With so-called leveraged loans — high-interest, floating-rate borrowing by companies with shakier credit — the ending still isn’t clear. Their growth has been explosive, providing more than $1.3 trillion in loans used by U.S. companies and private equity firms to do things like fund buyouts, pay shareholder dividends and refinance borrowings. But not all bubbles end with a bust — sometimes the air just leaks out of them. If there’s a happy ending, it might be the work of regulators who tried to crack down as debt piled up, or it might be because the money simply moved elsewhere as interest rates rose on safer alternatives.

The market for new U.S. leveraged loans had almost doubled between 2012 and 2017, when a record $1.1 trillion were issued. But loan sales fell to $814 billion in 2018, as global turbulence knocked the wind out of the assets starting in late October. Sales for December hit their lowest since 2011, prices plunged and investors pulled money from funds that invest in loans at a record pace. But, in a sign of how volatile leveraged loans can be, the market quickly began to rebound in January as buyers were lured back in by newly cheap valuations. The surge in 2017 had been fueled in large part by the U.S. Federal Reserve’s planned campaign of rate hikes, which made the floating-rate loans more attractive to some investors as a hedge against possible losses on fixed-rate borrowing. Leveraged loans also still offered more yield than the pervasively low rates on higher-rated investments. Adding fuel to the fire was a loosening of the limits that U.S. regulators had set on leveraged loans in 2013. Banks grew bolder in piling debt onto firms, often under easier terms, in a bonanza that led to expressions of unease from the Bank of England and the International Monetary Fund as well as the Fed. Leveraged loans are also on the rise outside the U.S., though the market is smaller and more of the debt is retained by banks.