It seems as if warning bells have been ringing in the sub-investment grade debt market forever. However, as commentators perpetually wail about covenant erosion and evaporating returns, all that happens is that the market gets bigger and bigger and bigger.
There are now $1.1 trillion leveraged loans outstanding in the US, according to S&P. The BIS quarterly review at the end of September asked if the rise of leveraged loans was a “risky resurgence”.
Chorus of concern
Even the IMF is concerned. In its most recent financial stability report, it pointed out that just over 50% of leveraged loan deals in the US had multiples of between 5 and 5.99, while around 28% had multiples of six or more. In Europe the numbers are even more concerning: 60% of deals have multiples between 5 and 5.99 and the number with a multiple of 6 or more is very nearly 30%.
The US multiples are a lagging indicator of the impact that lending guidelines – which have since been unofficially relaxed – have had on the market. The figures for Europe largely reflect what is going on in the UK, as that market accounts for a significant percentage of activity. UK non-financial companies issued a record £38 billion in leveraged loans in 2017 and have already written £30 billion in 2018.
The Bank of England joined the chorus of concern in its June 2018 financial stability report, stating that “sustained growth of corporate credit – even if facilitated by borrowing through capital markets – could affect the resilience of the core banking system… it could have an indirect effect on bank resilience, if highly leveraged companies amplify economic downturns by seeking to reduce their debt and thereby raising the risks banks face on all exposures.”
This is because much of this record leveraged lending ends up in CLOs that mark to market and so will be forced sellers in any downturn. The securitization bogeyman is alive and well, just in time for Hallowe’en.
One group of market actors remains stubbornly unaffected by the growing concern elsewhere: investors. Bond buyers didn’t blink an eye in October when ride-hailing app Uber attracted a $3 billion order book for its debut bond: an upsized $2 billion deal offering of eight- and five-year notes at yields of 8% and 7.75%, respectively. The private placement was led by Morgan Stanley.
The deal was swiftly followed by news that video streaming service Netflix, which plans to spend $8 billion on original content this year, also aims to tap the high yield bond market for the third time in less than a year. The firm raised $1.9 billion in November 2017, $1.6 billion in April this year and now plans to raise a further $2 billion from the bond markets. It already has $8.4 billion of high yield debt outstanding and has a projected negative cash flow of $3 billion.
Uber, which has raised $3 billion in the leveraged loan market since 2016, announced second quarter adjusted losses of $614 million in August (down from $773 million for the same period last year) and continues to burn cash on subsidizing rides, food delivery, electric bicycles and autonomous technology. According to CrunchBase, Uber has now raised $24.2 billion in 21 funding rounds.
Single B minus-rated carmaker Tesla raised $1.8 billion in the bond markets in August, paying 5.3% for eight-year money via Goldman Sachs prior to its chief executive’s well-documented meltdowns over the late summer. The firm has now raised $14.5 billion from 28 funding rounds according to CrunchBase, and burned through $1.2 billion in cash in the second quarter of this year.
Office space provider WeWork’s infamous covenant documentation for its upsized $702 million deal earlier this year didn’t seem to put off that many buyers, and despite tripling first half losses to $723 million, and having its rating withdrawn by Moody’s, the firm raised a further $1 billion from Softbank over the summer.
That investors have no qualms about throwing money at tech plays like this is perhaps understandable if they have a firm belief in their growth stories. But it is also an indication of the amount of liquidity still looking for a home in, perhaps, all the wrong places.
Euromoney has long argued that the extent of leverage now available to such credits will amplify the market shock when things go wrong.
There is no doubt that banks are now far more protected against a turn in the cycle than they were in 2007, but the same cannot be said for corporates. This is where concern is now focused, and for good reason.