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Libor Floor Protection Disappears from Leveraged Loans
About 70% of leveraged loans made to junk-rated companies in the second quarter lacked the so-called Libor floor, a mechanism intended to protect corporate lenders when short-term interest rates fall close to zero. Two years earlier, nearly all such loans had that safeguard, which became common following the 2008 downturn.
The Libor floor is designed to ensure that investors don’t lose too much of their interest income when Libor drops below a pre-defined level, generally set at 1%.
Bloomberg Business reported that investors’ willingness to forego Libor floors in the more than $1-trillion market for leveraged loans illustrates how little they worry about an economic downturn that brings rates back down to near-zero. At present, three-month Libor has been trending at about 2.35%.
Other parts of the credit markets reflect similar levels of confidence; e.g., the best performing U.S. corporate bonds this year are the lowest-rated. To Wells Fargo Asset Management’s Andy Hunt, though, “It’s another straw on the camel’s back,” referring to the disappearance of Libor floors from corporate loans.
“It’s not that any one of these things is catastrophic,” said Hunt, co-head of global fixed income and head of liability-driven investing and global credit at Wells Fargo Asset Management. “But put it together, you add it up to be a package of more borrower-friendly than investor-friendly characteristics.”
Investors are more worried at present about the Federal Reserve’s plan to continue increasing the benchmark federal funds rate. Yet Danielle DiMartino Booth, a former adviser to the Federal Reserve Bank of Dallas, warned that the yield curve is flattening and may soon invert, signaling a downturn.
“Investors are in complete and total denial that [Fed chair Jerome] Powell is going to magically, masterfully raise rates beyond the point of inversion and not disturb the economy at all,” said DiMartino Booth. “Chances are growing by the month that the Fed will be lowering rates before they know it.”
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- ◦Economy
- ◦Financing
