Leveraged loans are being repriced for a new era. JPMorgan data shows the share of US leveraged loans trading above face value has fallen to a 17-month low of 9.8%. Concerns over higher interest rates and the future of legacy businesses facing threats from AI and GLP-1 drugs are weighing on prices.
An underlying issue is also at play: a reckoning for the covenant-lite loans that exploded in popularity during the low-interest-rate years. As cov-lite deals spread, they often dropped the traditional financial tests that let lenders intervene early when a company struggled. Many of those loans have since been restructured through liability management exercises (LMEs), which often subordinate one group of lenders to another.
As aggressive LMEs proliferated, jitters over payouts crept into secondary-market pricing. Creditors who once expected buyout firms to look after them first now find themselves pushed behind other claimants, a breakdown of the traditional pecking order. The more interesting question is whether lenders are beginning to charge for that risk in the primary market, where new loans are issued. A paper earlier this year found that loans to companies owned by a sponsor seen as aggressive paid more to borrow than loans to companies owned by other private equity firms. A new study by Barclays' Corry Short downplays the "sponsor premium" but finds that stronger documentation, meaning better creditor protections, can meaningfully lower the risk premium on new issues.
The two factors are not mutually exclusive, since a sponsor's reputation and the room its legal team has under the loan covenants could both shape new-issue pricing. Credit analysts, who have traditionally focused on whether a business can repay its borrowings, now also have to weigh the game theory of sponsors and creditors, and the decay of creditor protections is changing what the job entails.
Source: Bloomberg Markets · Summarized by HeadlinesBriefing