Question
Why would the amount of debt/EBITDA be an important ratio when examining the problem of high debt, particularly with respect to the leveraged loans discussed
Why would the amount of debt/EBITDA be an important ratio when examining the problem of high debt, particularly with respect to the leveraged loans discussed in the Economist article be a particularly good ratio to examine?
The Economist:
https://www.economist.com/the-economist-explains/2019/01/11/what-are-leveraged-loans
LEVERAGED LOANS are at first sight a tautology. They are simply loans, usually arranged by a syndicate of banks, to companies that already owe a lot. Most are issued in America and are then packaged into "collateralised loan obligations", legal entities managed by private-equity firms, hedge funds and others, which slice up the loans and apportion them to their investors to suit those investors' taste for risk. According to S&P Global Market Intelligence, a data provider, over a third of leveraged loans refinance existing debt. A good chunk is used to finance mergers and buyouts. Some pay private-equity firms' dividends.
The market for leveraged loans has grown rapidly in the past few years. S&P Global Market Intelligence estimates that more than $1.4trn-worth was outstanding at the end of last year, twice as much as in 2011 (see chart). In 2018, $736bn-worth was issued, just shy of 2017's record. (Some estimates say the market is bigger still.) Lenders have been keen because leveraged loans have offered decent returns when interest rates have been ultra-low; because most are at floating rates, they pay more as rates rise. They are usually secured, giving some comfort if borrowers default. Borrowers like leveraged loans because they are more flexible than bonds. For instance, they are easy to repay early. Plentiful credit has gone hand in hand with a decline in credit standards. These days most loans have few, if any, "covenants" that would require borrowers to meet specified financial conditions in order to protect lenders if things go wrong.
In recent months warnings that the market might be heading for trouble have been getting louder. In April 2018 the IMF detected traits "reminiscent of past episodes of investor excesses". Janet Yellen, ex-head of the Federal Reserve, and Daniel Tarullo, a former Fed governor, have also sounded the alarm. This week Henry McVey, head of asset allocation at KKR, a big private-equity firm, recommended that investors reduce their exposure.
Two worries stand out. One is the risk of default. Slowing growth and rising American interest rates might harm borrowers' ability to repay and the value of collateral. The absence of covenants makes investors more vulnerable still. Moody's, a rating agency, reckons investors might salvage 61 cents on the dollar if borrowers default, against a long-term average of 77 cents. The second worry is of a downward cycle in prices as anxious investors seek to get their money back. In September the Bank for International Settlements fretted that downgrades of troubled borrowers could spark a "fire sale". That isn't happening yet, but some investors seem to be eyeing the exit: Bloomberg reports that loan prices fell last month.
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