A funny thing happened in the debt market this week. A $3.2billion loan deal once chastised as “the worst ever” in terms ofinvestor protections drew US$9 billion worth of orders, allowing itto be super-sized by almost a third.

The loan was part of a $10 billion leveraged buyout (LBO)financing package including bonds for Johnson ControlsInternational Plc car battery unit Power Solutions. It surged frominitial pricing of 99 to 100.25 in its first day oftrading—indicating extra appetite from investors beyond theoversized order book.

“The upsizing of the deal meant there were fewer bonds to sell,and they experienced their own feeding frenzy,” said CanaccordGenuity strategist Brian Reynolds. “Johnson Controls intends to usemost of the proceeds of the transaction to buy back stock. Theoverwhelming success of this deal makes it likely that there willbe more such financial engineering ahead.”

An almost complete recovery in credit markets since the sellofflate last year and a dovish Federal Reserve are refocusingattention on the multiyear boom in corporate debt, along with therisks that might now be stored up for a later date. For strategistsat Deutsche Securities Inc., “unstoppable risk-taking” in the formof debt-financed share buybacks and acquisitions is stirring uneasymemories of the previous financial crisis, when Wall Street churnedout a different type of security to satisfy rampant investordemand.

They argue that sluggish global growth, aging populations, andlow interest rates create a massive and long-running headache forbig investors such as pension and sovereign wealth funds: hugeliabilities that “require high asset returns to avertbankruptcy.”

In the years before the crisis, those returns were served by asmorgasbord of securitized products created by investment banksthat repackaged subprime loans into top-rated bonds. Investorsoften applied leverage, using derivatives or short-term funding, tojuice returns.

“To make 'processed food' capable of satisfying investors'voracious appetite for high returns, it is necessary to havehigh-calorie (high-yield) ingredients,” Deutsche analysts MasaoMuraki, Hiroshi Torii, and Tao Xu write in their note.“Accordingly, the finance and non-bank industries (investment banksat the top) cooked up a scheme to create high-yield loans bygetting low-income workers to buy houses.”

Fast forward to today, and a similar process is under way in thecorporate debt market, with highly leveraged companies becoming theingredient du jour and asset managers replacing investmentbanks as the servers dishing out products to a new group ofinvestors. The buyers now range from retail investors toexchange-traded funds (ETFs) to Japanese banks snapping up highlyrated bundles of leveraged loans.

“After the global financial crisis, investment trusts (includingETFs) stepped up their investments in low-grade corporate credit(mainly companies in the U.S. and developing countries),” theyargue. “Investment trusts have become enormous shadow banks forU.S. companies, providing 20 percent of their financing needs(corporate bonds and loans), compared with just 9 percent in2007.”

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