Wednesday, July 29, 2009

Leveraged loan rally continues

The leveraged loan market continues it's unprecedented rally in spite of the maturity wall we've discussed earlier (Leveraged loans - a race against time). Here are some reasons for the rally:

1. Dedicated capital: A great deal of capital had been raised to take advantage of the "dislocated" senior secured product. As the market started moving, that capital had to be put to work to avoid missing the rally.

2. Leverage is back: Banks are out there selling the Total Return Swap (TRS) product (more on the topic later). TRS allows investors to put up 1/4-1/3 of the capital for a portfolio of leveraged loans, with the rest financed by banks.

3. Little new supply: There has been little activity in the LBO market, so very few new syndicated loans are hitting the market. The few deals that have been done recently were structured with better terms and have rallied to levels above par such as loans to finance some of the $23 billion Mars acquisition of Wrigley (with Buffett's help).

4. Existing supply reductions: Supply is being taken off the market as firms default or issue bonds to pay down some of their loans. These paydowns leave CLOs with cash, forcing them to buy more loans (CLOs can't run large cash positions because not having enough asset/liability spread may cause them to violate their interest coverage tests).

The S&P/LSTA US Leveraged Loan Index (weighted based on dollar outstanding amounts):

On a yield basis, with LIBOR below 50 bp, leveraged loans are now yielding 6.75% (according to LPC).

Leveraged loan yield history:

So full speed ahead for leveraged loans. For now.

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