Leveraged loans are outperforming and remain very resilient. Initially, floating-rate debt will be more attractive to investors as rates start to rise.
But warnings regarding the leveraged loan market are increasing. The Federal Reserve Board, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency, flagged the ongoing “high” credit risk in the leveraged loan market back in their 2021 Shared National Credit (SNC) Review Report released in February.
The report was released on February 14th when the 2- and 10-year Treasury yields were at 1.58% and 1.98%, respectively. As of yesterday, 2- and 10-year Treasury yields were at 2.68% and 2.90%.
The benchmark rate that most leveraged loans are priced off is projected to rise from about 0.50% now to 3% in the next twelve months, according to Citigroup figures quoted in the WSJ. The speed of these interest rate increases will be unprecedented for many borrowers. Interest expenses are now climbing at the same time as wages, and other operating costs.
The outlook for small businesses is now deteriorating sharply. The NFIB small business optimism index slid in March to the lowest since April 2020. The outlook for general business conditions has deteriorated: sales expectations tumbled last month. Of course, NFIB survey participants will tend not to be listed. Nevertheless, small businesses are a harbinger for the broader economy. Larger corporates may feel the slowdown with a lag.
Vulnerability to rising yields will have now risen to the top of regulators’ concerns. Elon Musk’s proposed financing package for the takeover of Twitter would constitute one of the largest leveraged buyouts in history. The deal includes $25.5bn in debt, including a margin loan of $12.5bn against his shares in Tesla.
