Thursday, March 13, 2014

Leverage Loans Soar As The Toxic Debt Mountain Grows

In the 1990's we had a stock bubble. In the early 2000's we had a real estate bubble. Now we have the grande finale which is the bond bubble. Unfortunately, a large part of the reflation in stocks and real estate since 2009 has been due to the secondary impacts of the bond bubble. I say unfortunately because they will be hurt simultaneously when the bond bubble bursts.

A picture usually tells the best story and that is certainly the case for the chart below. The largest amount of froth within a bubble usually takes place in the most dangerous portion of the asset class. Near a peak, the lowest quality assets are lumped together with the highest quality because there have been no defaults in both the high and low quality issuance (think how subprime mortgages were priced the same as high quality mortgages back in 2005).

This is why junk bonds and leveraged loans have come storming back during the current debt mania. Investors have cast aside any notion that something could go wrong. It is only a matter of how much "yield" they can own, on leverage. Here is Investopedia's definition of a leveraged loan:

"Loans extended to companies or individuals that already have considerable amounts of debt. Lenders consider leveraged loans to carry a higher risk of default and, as a result, a leverage loan is more costly to the borrower. In business, leveraged loans are also used in the leveraged buy-outs (LBOs of other companies."

Higher risk of default? That only means higher yields in the minds of investors today. The blue line below shows the mind boggling issuance of leveraged loans over the past three months. This new mountain makes the 2007 issuance look like a mole hill.


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