This week we chat with Andrew Brady, Managing Director and Leveraged Loan Portfolio Manager of Marathon Asset Management, L.P.  Marathon is a global credit manager with approximately $13 billion of capital under management investing in the global credit markets.

The Lead Left: Andrew, it’s been a while since our last conversation. What’s your view of the current market environment?

Andrew Brady: We have seen significant market volatility and major changes in lending conditions in recent years, including continued convergence of terms in high-yield markets between loans and bonds. Terms and risk for many bonds look like loans and vice versa, particularly for larger companies but also in certain middle market issuers, including more unsecured loans and secured bonds. This has been driven partly by the growing base of global investors desperate for yield, which is unavailable in the largest bond markets. These investors see no maintenance covenants on investment-grade bonds or high-yield bonds (with generically lesser and greater risk than leveraged loans, respectively) and therefore do not push for covenants on loans. Still, covenant lite debt is not inherently bad; credit quality is far more complex than a single term.

Other aggressive changes in terms are more troublesome, including loose baskets for restricted payments, investments, debt incurrence, and M&A. Hazards for investors further increase by pairing such terms with inherently aggressive transactions, which have become prevalent. For example, quick dividends after an LBO, aggressive add-backs to earnings, and focus on projected earnings rather than proven performance. We simply assume much of the marketed earnings are false, and often refer to covenant limits as “debt divided by fiction.” For example, we have long followed one leveraged company and were puzzled by purported earningsduring a major acquisition that were almost double our calculations. We kept hearing “Hey, it’s only 6x leverage.” It’s beholden upon institutional managers to protect investors from such nonsense.