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Leveraged Loans Are the Weakest Link in U.S. Credit, UBS Says

Leveraged Loans Are the Weakest Link in U.S. Credit, UBS Says

(Bloomberg) -- Leveraged loans are suffering a “slow bleed” and are the weakest link in U.S. credit markets, says UBS Group AG, adding to an expanding list of warnings.

“We are growing more concerned over the deterioration in loan fundamentals, which is broad-based and appears less related to trade and more to fading cyclical momentum and a hangover from an M&A-driven debt boom,” UBS credit strategists led by Matthew Mish wrote in a report dated yesterday. They are watching the leveraged loan and private credit markets most closely.

Leveraged Loans Are the Weakest Link in U.S. Credit, UBS Says

More than a decade since the last global recession, money managers are growing nervous about what may be the trigger for the next potential crisis. Aberdeen Standard Investments has also expressed concern about potential strains in credit markets where liquidity is low. For strategists at Deutsche Securities Inc., “unstoppable risk-taking” in the form of debt-financed share buybacks and acquisitions is stirring uneasy memories of the previous financial crisis. Read more about that here.

“The cushion from material downside is narrower,” even as signs of deterioration remain modest, according to UBS. The sectors that are most at risk have above-average leverage and below-average coverage, and include software, health care and business services, the strategists said.

Things will likely get worse ahead. Leveraged loan spreads will widen to near 450 basis points from about 403 basis points, according to UBS.

Other highlights

  • Leveraged loan sentiment is “closer to neutral” given “inverse relationship between monetary policy (dovish) and flows (out) and with persistent credit risk concerns”
  • There has been concern that rule changes in Japan, home to some of the biggest buyers of bundled leveraged loans, could affect the market. But Japanese authorities’ final risk retention rules “appear to have averted worst-case scenarios of an end to the Japan bid,” the strategists said
  • UBS strategists say they are not overly concerned with credit excesses outside loans, and their credit models don’t show heightened risk of a downturn
  • UBS high-yield bond year-end spread target is 435bp, up 53bp vs current

To contact the reporter on this story: Finbarr Flynn in Tokyo at fflynn3@bloomberg.net

To contact the editors responsible for this story: Andrew Monahan at amonahan@bloomberg.net, Ken McCallum

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