Leveraged loans continue to make headline gains as private equity seeks dividend recapitalizations, buyouts and to refinance debt at favorable terms. A new report from LCD, a S&P Global Market Intelligence offering sheds some light on the depth of the phenomenon, and on potential risks as LBOs increasingly focus on lower rated targets.

The momentum that put the leveraged loan market on track to surpass previous records is no longer theoretical. As of October, the $509 billion in loan volume has exceeded the prior $503 billion all time high set in 2017.

What’s driving the increase? Leveraged buyouts continue to constitute the lion’s share of new issuance, but dividend recaps are representing a larger slice of the pie than usual, up 84 percent in the year through Oct.12, over 2018 figures (the previous high-water mark).

That could raise issues for the market in the long run given the credit quality of targets. Despite a rebound in post-Covid expectations for most segments, “LCD data shows that M&A activity this year in the U.S. is being driven by lower-rated transactions. In fact, volume of loans issued to borrowers rated single-B has set an annual record, at $360 billion through Oct. 12,” the note reads.

Government assistance to select industries set off a wave of chatter about ‘zombie’ companies last year, but the new corporate walking dead might be this year’s vintage of private equity targets. Should interest rates and rising valuations stop the ongoing M&A mania, quite a few financial sponsors could be left holding highly indebted portfolio companies with historically low abilities to cover their debt burdens.

Brandon Zero