The Credit Bubble Is Not Only Back, It Is 94% Bigger Than In 2007

If the Fed was worried about 'froth' in the markets earlier in the year, then this chart should have them panicking. Of course, as Jim Bullard noted Friday, there is no bubble because everyone knows there is no bubble but judging by the massive surge in covenant-lite loan issuance, there is a bubble in forced demand for leveraged loans. At $188.7 billion, the 2013 issuance of these highly unsafe loans (which have seen huge inflows since the Fed started talking taper back in May) is almost double that of the peak of the last credit bubble in 2007 and is five times the size of 2012 YTD issuance at this time. As Reuters notes,Covenant-lite loans used to be reserved for stronger companies and credits, but are now so common in the U.S. leveraged loan market that investors are becoming wary of some credits with a full covenant package. With corporate leverage at all-time highs, what could go wrong?

Demand for leveraged-loans is surging (as rate concerns rise)...





And where there is demand, supply rises to meet it - as the least lender-protected notes surge in issuance...



(Data: Morgan Stanley S&P LCD)

Huge demand for leveraged loans from billions of dollars flowing into U.S. loan funds pushed covenant-lite loan volume to a record $188.7 billion, far surpassing the record of 2007, and still going strong.

Unrelenting investor demand for higher-yielding assets and floating-rate exposure has enabled issuers to sell these loan products that allow for future acquisitions or aggressive credit policies, but offer less protection for investors.

Investors have poured money into floating-rate loans, fearing a rise in interest rates, and private equity firms have taken advantage of the demand to get looser debt structures.

Covenant-lite loans used to be reserved for stronger companies and credits, but are now so common in the U.S. leveraged loan market that investors are becoming wary of some credits with a full covenant package.

"Transactions with covenants these days can suggest other problems with the credit, maybe that it is new to the market, or exiting from bankruptcy," said Christina Padgett, senior vice president at Moody's Investors Service.

Covenant-lite has mainly been used by private equity firms, but non-sponsored issuers seeing the robust investor demand have begun seeking these financings.

"There's a tremendous amount of demand and only so much supply. When there's more demand than supply, you can certainly do things like get covenant-lite packages through," said one portfolio manager.

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