The Federal Reserve, along with plenty of money managers and market analysts, have been concerned about lax lending standards as investors search for better yields. Critics may find some solace in learning that total leveraged loan volumes fell to $315 billion in the first half of this year from $404 billion in 1H13, but covenant lite loans mostly held their ground, now making up slightly more than half of institutional loan issuances.
“U.S. institutional loan issuance in the first half failed to match last year’s record pace, though issuance was still double that of the same period of 2012. Covenant light accounted for more than half the total, and continued strength in sales of second-lien debt and loans to fund dividends and LBOs helped set the pace,” write BloombergBriefs data analysts Lara Deke and Nikolas Trenchi.
Second lien loan volumes grow and margins fall
Covenant lite loans offer lenders less protection (eg lower income levels, lower quality collateral, more flexible repayment terms) in exchange for higher yields, and their growing popularity has been one of the many signs that investors are getting pushed out on the risk curve as historically low Treasury yields pull down returns on forms of credit.
You can see the same effect in second lien loans which have grown from practically nothing in the first half of 2009 to just under $20 billion for 1H14, while margins have tightened again spreading out during the second half of last year.
Record volume of loans used for dividend payments in 1H14
For those who are still waiting for capex to reach the levels you would expect for an economy whose recovery is well underway, the amount of loan issuance being used to pay dividends hit a new high in 1H14, rising to $38 billion from $37 billion last year. That might be a small absolute increase, but it means that dividends were behind about 12% of institutional loan issuance in the first half, up from 9% in 1H13.
One of the main criticisms of this bull market is that stock prices have driven by a cycle of cost cutting and financial tactics more than by reinvestment and organic revenue growth. When the credit market is accepting low quality loans to finance dividend payments to the equity markets it’s hard not to heel like the trend is continuing.