Leveraged loans may have a role in recent retail bankruptcies. Leveraged loan volume is nearing pre-recession highs and is on track to surpass 2007 levels, concerning many regulators and investors. Leveraged loans are typically offered to companies that already have large amounts of debt, and therefore, leveraged loans carry higher interest rates due to an increased risk of borrower default. Companies often use leveraged loans to finance mergers, refinance debt, or for general company purposes. Private equity firms also utilize leveraged loans in order to fund takeovers of companies, including struggling retailers. Loans issued to fund leveraged buyouts from private equity firms rose 74 percent in 2017 and totaled 88.5 billion dollars. Additionally, nearly a third of loans to companies backed by private equity firms are leveraged six times or more.
The increase in leveraged loans before the 2008 financial crisis signaled an overheated market. As the financial crisis began to worsen in 2008 and beyond, leveraged loan investors lost nearly 30 percent of their portfolios.
Experts also worry that leveraged loans are contributing to an increase in retailers filing for bankruptcy. Many of the retailers that filed for bankruptcy over the last several years were purchased by private equity firms – often incurring more debt in the process. The debt of a recent large retailer that filed for bankruptcy included a significant amount of leveraged loans and high-yield bonds. Though loans to fund private-equity buyouts of companies are still significantly lower than the pre-recession volume, financial experts are becoming increasingly cautious.
Regulators have noted that US companies are at their most leveraged point since 2000. 75 percent of new loans are considered “covenant-lite,” meaning borrowers could, for example, incur as much debt regardless of their financial performance. If interest rates rise or the economy downturns, the amount of leveraged loans now existing could put pressure on financial markets.