FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
January 7, 2020

IN THIS ISSUE:

1. My #1 Goal For The New Year

2. The “Leveraged Loan” Market: What You Need to Know

3. Leveraged Loan Credit Downgrades Spiked in 2019

Overview

If you read last week’s issue of Forecasts & Trends, you know that I am optimistic we’ll have another positive year for the US economy, although perhaps a little slower. With interest rates and inflation remaining very low, it should also be another good year for the stock markets. That could change, of course, if there are significant negative surprises.

Among the things that concern me about the New Year is the explosion in debt among US corporations with credit ratings below “investment grade” (ie – BBB- or lower). Many well-known companies fall into this category, including Burger King, Chrysler, Dell, American Airlines, Avis and many other high-profile corporations. In fact, over 70% of companies in America have below investment grade credit ratings. That may surprise you.

Many of these low-rated companies have surprising levels of debt referred to as “leveraged loans” that are experiencing rising downgrades and default rates, particularly in 2019. While small in comparison to total outstanding corporate debt, these leveraged loans pose a threat to our financial system should the current trend continue.

Most Americans have no idea this is happening, so that’s what I’ll talk about today. I want to make sure my clients and readers are aware of this potentially dangerous situation and know what to watch for.

But before I get to that, I have a few thoughts to share as we enter the New Year. I also want to share with you my #1 goal for 2020. Let’s get started.

My #1 Goal For The New Year

As we begin a new year and a new decade, I reflect back on my views and opinions over the last year, and in this case, the last decade. As I discussed last week, I remain positive about the economy and the stock markets for 2020. Come to think of it, I have been decidedly positive about the US economy and the equity markets for a very long time.

In early January each year, we see a slew of articles by various writers who point out how most forecasters got it wrong in the previous year. Such articles this month noted how most forecasters predicted a recession and the end of the equity bull market in 2019. As regular readers know, I was not among those predicting such a dire outcome last year.

No, as long-time readers know, I have been quite positive about the US economy and the stock markets for the last decade. As time has shown, that was the correct position to hold. As usual, the gloom-and-doom crowd was wrong. Such a time will come, of course, but I don’t think we’re there yet. When I do, you’ll be the first to know.

My point is, you can always find gloom-and-doomers, even some high-profile ones, who warn that dark times are just ahead, even if they are consistently wrong year after year. Why? Fear sells! It gets people to write checks and in too many cases causes people to invest accordingly. My hope is to help steer you clear of such decisions – until the time comes.

There was a time early in my career when I bought into the gloom-and-doom scenario. For a time, I believed the worst was just ahead of us. Fortunately, a wise client turned me onto The Bank Credit Analyst many years ago, which had a much more optimistic outlook for our future and the markets. It didn’t take me long to come around and shelve my gloom-and-doom views.

As we begin this New Year, I hope clients and readers appreciate my positive point of view. I believe in reading the best and most objective research and distilling that information into what I write for you. That is what I try to bring to the table week in and week out as best I can.

There will be a time for gloom-and-doom, no doubt about it. With our government now $23+ trillion in debt, that time may be coming sooner than we think. But for now, I don’t believe we’re there yet. When we do get there, my hope is to be able to warn you in advance.

My #1 goal for this year is to convince more of you to reconstruct your investment portfolios to include successful strategies that have the potential to make you money whether the stock markets move up or down, and other strategies that don’t invest in stocks at all.

This is what I truly believe most investors should be doing to transition for when the bad times come, and they will. To do so will mean that many of you will have to think outside the box, as they say. I’ll do my best to help you get there this year and beyond.

Thank you for your continued confidence. I encourage you to share my work with others. I also appreciate your comments and suggestions – please keep them coming!

The “Leveraged Loan” Market: What You Need to Know

Please bear with me for a few brief paragraphs as I explain what leveraged loans are and how they work. Leveraged loans are typically extended to companies that already have considerable amounts of debt and/or a poor credit history. Lenders consider leveraged loans to carry a higher risk of default, and as a result are more costly to the borrower.

A leveraged loan is typically structured, arranged and administered by at least one commercial or investment bank. These lending institutions are called “arrangers” and subsequently may sell the loan, in a process known as “syndication,” to other banks or investors to lower the risk to the lenders.

Companies typically use leveraged loans to finance mergers and acquisitions (M&A), recapitalize their balance sheets, refinance debt or for general corporate purposes. M&A could take the form of a leveraged buyout (LBO) in which a company or private equity fund purchases a public entity and takes it private. Typically, debt is used to finance all or a portion of the purchase price. US corporations across many sectors use leveraged loans.

Leveraged loans are tracked and monitored by the Standard & Poor’s “Leveraged Commentary & Data” (LCD) unit, the world’s largest provider of leveraged loan news and analytics, and the Loan Syndication & Trading Association (LSTA) – which cover loans rated BB- or lower.

Finally, growth in leveraged loans has been rising significantly since 2012, despite the continued growth in the US economy. Leverage loans, as tracked by the S&P/LSTA Index, topped $1 trillion in April of 2018 and have continued to increase since then according to The Wall Street Journal. As of early 2019, there was $1.7 trillion in leveraged loans outstanding.

The bottom line is that leveraged loans are typically extended to companies that already have considerable debt and are therefore considered riskier than conventional loans. Default occurs when a borrower can't make any payments for an extended period.

Leveraged Loan Credit Downgrades Spiked in 2019

The Wall Street Journal reported on December 27 that credit downgrades on leveraged loans increased significantly in 2019. The ratio of downgrades to upgrades in the S&P/LSTA Leveraged Loan Index rose in the 12 months through September to nearly 3 to 1 -- the highest reading since 2009 in the wake of the financial crisis. A total of 282 issuers were downgraded from the beginning of January through early October last year, up from 244 in all of 2018 and only 33 in 2017, according to S&P and LSTA.

Leveraged loans are junk-rated corporate loans, a favorite financing source of private equity firms seeking to buy up companies they see as undervalued, or in need of a makeover to turn a profit. Investors watch the leveraged loan market because many view it as a barometer of credit conditions. Tightening credit conditions could cause a slowdown in corporate or even consumer lending, thus hurting the economy,

The market for leveraged loans has grown significantly in recent years, supported by the creation of collateralized loan obligations (CLOs) and investors’ hunting for yield in a world where central banks’ easy-money policies have pushed capital into riskier assets.

A recent report by the Financial Stability Board, an international watchdog, warned of risks to the global financial system posed by leveraged loans, citing the lower quality of corporate debt and changes in loan documentation.

I bring the subject of leveraged loans to your attention today, as we start off the New Year, as it is a topic I want to get on your radar screen. While not yet a crisis, further deterioration in this rapidly growing debt market is something we want to watch closely.

Since this has been only a quick introduction, I encourage you to read more about it just ahead. Just Google “leveraged loans” and you’ll find plenty to get you started. I will continue to monitor this situation and will have more to say on this topic in the weeks and months ahead.

Best regards,

Gary D. Halbert

SPECIAL ARTICLES

Leveraged Loans Top $1.7 Trillion in 2019

Leveraged Loans Are Riskier Than Many Think

Gary's Between the Lines Blog: Despite Media Claims, US Middle Class is Flourishing

 

Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc., a Registered Investment Adviser under the Investment Advisers Act of 1940. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of the named author and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific advice. Readers are urged to check with their financial counselors before making any decisions. This does not constitute an offer of sale of any securities. Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have their own money in markets or programs mentioned herein. Past results are not necessarily indicative of future results. All investments have a risk of loss. Be sure to read all offering materials and disclosures before making a decision to invest. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.