As interest rates rise and companies try to refinance debt, the market for junk loans may be setting itself up for considerable losses, according to Bloomberg news. That’s the conclusion of Martin Pfinsgraff, senior deputy comptroller for large-bank supervision in the Office of the Comptroller of the Currency.
As Pfinsgraff told Bloomberg News, the likelihood of default and debt restructuring is very high.
“Because of the rapid increase in the volume of leveraged issuance the past three years,” he said, “the magnitude of potential losses under a stress scenario may likely increase from the prior cycles.”
Citing data it compiled, Bloomberg notes that “the Federal Reserve is fueling demand for high-yield debt, with banks already arranging $337 billion of U.S. leveraged loans sold to institutional investors in 2014.” This figure is in addition to a “record $695 billion in 2013.”
Making matters less auspicious for junk loan borrowers is the fact that “half of the loans … lack standard lender protections such as financial maintenance requirements.”
And, as OCC’s Pfinsgraff told Bloomberg, because economic stress traditionally prefigures a drop in borrowing costs, it paves the way for “highly indebted issuers to refinance at lower interest rates.”
“Because the existing high volume of leveraged loans has been underwritten at record-low rates,” he says, “there will be little opportunity to refinance should economic stress arise.”
Just three months after the September 2008 collapse of Lehman Brothers, leveraged loan prices sank to 59.2 cents on the dollar, says the news outlet. This July 1, high-yield, high-risk debt soared to 99.1 cents on the dollar, according to the S&P/LSTA U.S. Leveraged Loan 100 Index, “the highest since July 2007.”