Friday, September 17, 2010



I often send my Investments and Financial Strategies students notes alerting them to relevant and educationally productive articles in various publications, usually the Wall Street Journal. This morning, I got a little carried away in my expression of enthusiasm for the subject matter of the cited articles, so I thought I would post this particular “heads-up” note on my blog:



On page C1 of today’s Wall Street Journal, we learn that leveraged loans (the senior “bank debt” component of the capitalization (broadly defined) of highly leveraged companies) are making a comeback, with demand for such loans, primarily from mutual funds and pension funds, becoming nearly insatiable as investors stretch for yield in what has become a desert for those parched for liquidity. This resurgence is especially notable because the leveraged loan market was, as the Journal put it with perhaps a bit of exaggeration “one of the markets at the heart of the credit bubble…”

A few points:

--People seem to have awfully short memories (or perhaps the memories of others just seem short when one’s memory, like that of your instructor, gets so very long) or a grossly inflated sense of their own ability to evaluate credit.

--People always seem to reach for yield at the precise time that they shouldn’t reach for yield. Usually, such reaching involves moving out the yield curve, but can also, but less obviously, manifests itself, as in this case, in taking on more risk at inopportune times.

--People also seem to invest in a great deal of “rear view mirror” investing. Note that the leveraged loan market has returned 6% this year and 43% since 12/31/08, awfully tempting for those who engage in cursory analysis. A further note: I’m uncomfortable with a generic reference to the “leveraged loan market,” just as I am uncomfortable with a generic reference to the “high yield market” or the “junk bond market.” Perhaps my attitude is forever sullied by being present at the creation of the former and near the creation of the latter, but I still think both these markets are so heterogeneous as to defy pat indexation.

--Perhaps I am just an old fuddy-duddy who has grown tired of risk in his dotage and therefore reacts with a degree of trepidation to leveraged loans in companies with debt at 6 times EBITDA. (We did buy junk bonds issued by companies with far higher debt/EBITDA ratios in the ‘80s, when I was a younger and, certainly in my estimation, smarter man.) Further, I don’t think rates of 400 bps (basis points) over LIBOR, or around 5%, could possibly compensate me for the risk in most such deals. Even further, the floating nature of these rates provides some comfort in an environment of low interest rates but an increasing LIBOR rate is the least of my concerns with such paper.

Maybe, again, my conservative nature has overwhelmed my youthful sense of adventure and these leveraged loan deals are the greatest thing since the introduction of White Castle. But I am far happier with my heavy investments in gold and silver, which have returned 16% and 23% so far this year.

We talked about Carl Icahn in the MBA class this week. Speaking of Mr. Icahn, and financial leverage, page B3 of today’s Wall Street Journal informs us that Mr. Icahn has purchased a third of Blockbuster’s senior debt, and he didn’t do so to start clipping (non-existent at this stage) coupons! It’s always interesting to see Mr. Icahn and his target managements vie to create ever higher levels of “shareholder value.”


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