WWRR Vol.2.015

Christopher Wood christopher.wood@clsa.com +852 2600 8516
aggregate leveraged loans rose from US$0.62tn at the end of 1Q11 to US$1.2tn at the end of 2Q18
(see Figure 17). The BIS study also notes that corporate restructuring, such as mergers, acquisitions
and leveraged buyouts, have accounted for nearly 40% of US institutional leveraged loan issuance
since 2015.
Figure 17
Leverage finance outstanding
(US$tn) US HY bonds
3.0
Europe HY bonds
US lev loans
Europe lev loans
2.5
Lev loan share (RHS)
2.0
1.5
1.0
0.5
(%)
70
60
50
40
30
20
10
0.0
0
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Source: BIS – Quarterly Review: September 2018
Figure 18
Covenant-lite loans as % of leveraged loans
90
(%) Covenant-lite as % of leveraged loans
80
70
60
50
40
30
20
10
0
2011 2012 2013 2014 2015 2016 2017 2018
Source: BIS – Quarterly Review: September 2018
A further sign of growing vulnerability is investors’ increasing willingness to accept weaker
protection. Thus, the fraction of so-called covenant-lite loans reached its post-GFC peak in late
2017, rising to 82% in 3Q17 and was 77% in 2Q18 (see Figure 18). The demand for these loans has
been increased by the growth in so-called loan mutual funds since 2016 (see Figure 19). Assets
under management in loan funds have risen from US$107bn in February 2016 to US$171bn in July
2018. This in turn raises the risk of loan defaults and resulting mutual fund redemptions leading to
forced selling. Meanwhile, the leveraged loans are attractive in a period of rising interest rates
because they offer a return indexed to the interbank rate. Still, the price of the S&P/LSTA Leveraged
Loan Index has now declined to its lowest level since December 2016, though the long-term chart
shows there is a lot of room for a further fall (see Figure 20). Indeed, macro investors are advised to
short this index now, if they have not already done so.
Thursday, 22 November 2018 Page 9