Late-Cycle Boost and Boom
High-Yield and Bank Loan Outlook Report
Third Quarter 2018
- Highly leveraged corporate borrowers are thriving in the current environment. Earnings growth accelerated to 18 percent year over year in the first quarter 2018 for high-yield corporate bond issuers. Bank loan issuer earnings growth was also strong at 9 percent. Defaults have declined, leverage ratios have improved, and coverage is healthy.
- The Federal Reserve’s confidence in the U.S. economy has sharpened in recent weeks. Nevertheless, geopolitical risk continues to weigh on the market, as positive headlines are offset by the trade war launched by the United States.
- The late-cycle fiscal boost is stoking more investor complacency in the institutional loan market. Recent primary market trends are reminiscent of 2006 and 2007 activity, when heavy activity related to mergers, acquisitions (M&A) and leveraged buyouts (LBO) preceded the financial crisis.
- Higher M&A and LBO volume is typically accompanied by higher leverage multiples. An increasing share of loans are being issued with 6x or greater leverage multiples, adding risk to a market that for the first time may experience a credit cycle turn without much covenant protection.
- Although we are not seeing the same level of M&A and LBO activity in the high-yield corporate bond market, it is not entirely immune due to M&A volume in the investment-grade corporate debt market. Fallen angels may create price dislocations in the future.
- Given little dispersion in pricing, increasingly similar credit profiles, and a convergence in covenant protection between the high-yield and the bank loan markets, we believe opportunities are beginning to look equally attractive in both sectors, but this remains a credit-picker's market.
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Investments in fixed-income instruments are subject to the possibility that interest rates could rise, causing their values to decline. High yield and unrated debt securities are at a greater risk of default than investment grade bonds and may be less liquid, which may increase volatility. Loans are often below investment grade, may be unrated, and typically offer a fixed or floating interest rate.
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