How to Kill a Debt Boom
A debt boom died quietly this year.
Investors simply stopped buying U.S. leveraged loans. As a result, this $800 billion pool of risky corporate debt is on track to shrink for the first year since 2008 after more than doubling in the previous six years.
This, perhaps, is a case study in how a market can’t have it both ways. It can’t follow its own rules and maintain an antiquated infrastructure while also remaining popular among 21st-century investors. Something’s gotta give, and in this case, investors are leaving. Hedge funds are backing away and mutual-fund buyers have pulled $15 billion so far this year, data compiled by Barclays show.
This may seem curious, because there’s still demand for junk bonds, which are cousins of leveraged loans. Both markets serve to finance less-creditworthy companies, and both promise to pay investors higher yields than on safer debt.
But there are some critical differences.
Loans avoid a whole bunch of regulatory oversight because they aren’t considered securities. And they trade as if it were still 1987, complete with whirring fax machines and teams of lawyers and corporate officers signing off on transfers of ownership. So even though traders can agree pretty quickly to trade a loan, they still may have to wait weeks, or even months, for settlement as all the paperwork is completed.
It’s not easy to fix an $800 billion market, and many investors and banks have been trying. It just hasn’t happened fast enough to avoid the furrowing of brows at the Securities and Exchange Commission and among investors, who worry about being able to cash out in a timely fashion. While these fears are overblown in some cases, the warnings have tarnished the reputations of loan funds that otherwise would be an obvious alternative to high-yield bonds.
Meanwhile, the market’s main organization, the Loan Syndications & Trading Association, has stopped releasing information on how long it takes to settle trades of existing loans, and it didn’t invite media to its annual conference at the end of this month. This doesn’t exactly inspire confidence.
It's no wonder that given the choice between bonds and loans, investors are increasingly choosing bonds, which trade more frequently and easily.
There are some solid arguments for why loans can appeal to investors. They are pegged to floating-rate benchmarks, meaning they should pay out more as rates rise, as opposed to bonds, whose rates are mostly fixed. Also, loans typically stand to get repaid before bonds if the borrower becomes insolvent.
But an opaque and archaic market is going to scare away a lot of investors, regardless of its advantages. Until some more transparency and efficiency finds it way into this market, it will continue to have a lid on its ability to finance American companies.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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