Markets: Dwindling ‘Debt Cushions’ Threaten Safety of Leveraged Loans

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Hello. Amrith Ramkumar here setting up the last trading day of the week.
Stock futures are climbing following yesterday's 0.1% rise for the S&P 500. Intel is tumbling premarket following downbeat results late yesterday, while Starbucks is higher following its fourth-quarter report. Major indexes are on track to snap a streak of four consecutive weekly advances.
Plus, our Sam Goldfarb examines a trend that could hurt the safety of leveraged loans.

Markets in a Minute

Markets Data

Overnight Developments


More Companies Issuing Loans Not Protected by Junior Debt

By Sam Goldfarb, bond market reporter
More companies with low credit ratings are limiting their borrowing to loans that would be repaid first in a bankruptcy, a trend that stands to undermine loans’ reputation as a safe investment.
At the end of last year, roughly 27% of first-lien loans—the most senior type of debt that is typically held by investors—were backed by companies with no junior debt outstanding, according to LCD, a unit of S&P Global Market Intelligence. That was the largest share in records going back to 2007, up from 26% in 2017 and 18% in 2007, at the height of the last economic expansion.
The presence of more junior debt is often referred to as a “debt cushion” for investors in first-lien loans. Junior bonds and loans typically absorb losses first in a bankruptcy, while senior lenders typically get most or all of their money back.
The math works this way. If a bankrupt company with $5 billion of unsecured bonds and $10 billion of first-lien loans were determined to be worth $10 billion, bondholders would be completely wiped out, while loan holders would get all their money back.
But if the same company had $15 billion of loans and no bonds, loan investors would get back only 67 cents on the dollar.
The shift to more “senior” loan sales comes as some investors question the safety of fixed-income investments following a decade of heavy issuance. During the next economic downturn, many analysts expect loan recoveries to be lower than normal, in part because of shrinking debt cushions.
Businesses aren’t legally bound to protect lenders by issuing more-junior debt. Their ability to borrow via first-lien loans is determined by the level of demand from investors and the terms of existing credit agreements, which typically limit the amount of secured debt they can issue.
Thinner debt cushions are the direct result of loans’ outsized popularity in recent years. As investors have flocked to them—drawn by floating-rate coupons that rise when the Federal Reserve lifts interest rates—credit terms have eased, ensuring a steady flow of new debt.
Online ticket vendor Vivid Seats in June raised $115 million by adding to its existing first-lien loan, to largely pay down its $185 million second-lien loan. Despite the increasing risk for first-lien lenders, the company made no change to the loan’s interest rate, which was more than five percentage points below its more junior loan, according to LevFin Insights.
Such transactions can be frustrating to investors.
“As a lender when you look behind you, there should be something there,” said George Goudelias, a senior portfolio manager and head of leveraged finance at Seix Investment Advisors.

Market Facts

  • The PHLX Semiconductor Index rose 5.7% Thursday, just its seventh one-day climb at least that large in the past decade. The advance came following earnings from Texas Instruments, Lam Research and Xilinx.
  • Natural-gas stockpiles fell 163 billion cubic feet during the week ended Jan. 18, the largest weekly drop in nearly a year, according to government data released Thursday. Natural-gas consumption tends to rise in the winter as more people turn on their heaters. Prices rose 4% Thursday but are still 36% below their November multiyear highs.
  • On this day in 1997, pyramid schemes promising returns of 8% per month collapsed all at once throughout Albania. Furious mobs of bilked investors besieged the nation’s deputy prime minister, Tritan Shehu, who cowered for safety in the locker room of a soccer stadium. By some estimates, $1 billion—or 30% of the nation’s gross domestic product—was invested in the Ponzi schemes. Investors lost nearly everything—and ended up overturning the government.

Key Events

U.S. durable goods orders and new home sales for December are delayed because of the shutdown.
The Baker-Hughes rig count is slated for 1 p.m. ET.
The World Economic Forum annual meeting continues in Davos. You can follow the WSJ's coverage here.

Must Reads

Rep. Maxine Waters, the new chairwoman of the financial-services panel, has pledged to review the activities of the banking sector. PHOTO: J. SCOTT APPLEWHITE/ASSOCIATED PRESS
CEOs of six top banks will testify before Congress. The chief executives of the six largest U.S. banks are poised to testify together before House lawmakers in Congress this spring for the first time since shortly after the financial crisis. The hearing marks an opening salvo in House Democrats’ plan to put the industry back in Washington’s crosshairs.
China is countering its selloff by cutting markets some slack. Unlike in 2015-16, when a crash led to greater distrust of market forces, Beijing has sped up financial liberalization in recent months, seeking to attract foreign capital and revive an anemic stock market.
The financial abuse of seniors has hit a record. U.S. banks reported 24,454 suspected cases of elder financial abuse to the Treasury Department last year, more than double the amount five years earlier.
Lawmakers are promising a fresh push to overhaul housing finance. Lawmakers from both parties plan to take a fresh crack at getting Fannie Mae and Freddie Mac, two companies that underpin nearly half of U.S. mortgages, out of government control.
A Davos debate: What is finance for? The head of a large long-term investor has a warning for shareholders and the financial elite meeting at the World Economic Forum in Davos: Start acting like owners of the companies in which you invest.
PG&E shares jumped after California cleared the company in a 2017 fire. Investigators said the Tubbs Fire was caused by a private electrical system, not PG&E equipment.
Bond prices jumped in Venezuela. Venezuelan bond prices have surged amid hopes that pressure against President Nicolás Maduro will lead to a new government with which creditors can negotiate to restructure debts the country defaulted on in 2017.

“Poor, violent and isolated, Venezuela’s latest indignity is that, to energy mavens at least, it is becoming irrelevant.”
—Heard on the Street columnist Spencer Jakab

Stocks to Watch

Intel: The chip maker missed sales targets and projected slower growth for this year. Shares rose 3.8% Thursday, boosted by strong results from other semiconductor companies.
Starbucks: The coffee giant reported a 9% revenue increase for its latest quarter as same-store sales performed better than expected.
Discover Financial: The financial-services company posted weaker-than-expected quarterly profits.
E*Trade: The discount brokerage said quarterly sales increased less than Wall Street had anticipated.
Intuitive Surgical: The company missed earnings expectations despite shipping a growing number of its da Vinci surgical systems.


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