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Bank of England:Leveraged loans like US sub prime


sancho panza

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hattip Moneyweek

 

Banks lending recklessly,whodda thunk it?

https://www.theguardian.com/business/2018/oct/17/bank-of-england-high-risk-lending-leveraged-loans

The Bank of England has issued a stark warning over the rapid growth in lending to indebted companies around the world, drawing parallels with the US sub-prime mortgage market that triggered the 2008 financial crisis.

Threadneedle Street said Britain was not immune from a global boom in risky lending that had alarmed financial regulators around the world this year, with the US market for such loans more than doubling since 2010 to surpass $1tn (£763bn).

“The global leveraged loan market was larger than – and was growing as quickly as – the US sub-prime mortgage market had been in 2006,” the central bank said of the rapid growth in leveraged loans, which are defined as loans to firms that already have debts worth more than four times their earnings.

The Bank’s financial policy committee (FPC), set up after the crisis to assess the risks to UK financial stability, noted that lending standards were falling and that it would more closely monitor the risks to Britain.

 

Though far from the scale of the US market, which is the largest in the world, gross issuance of leveraged loans by UK companies reached a record £38bn in 2017, while a further £30bn has been issued so far this year.

Taken together with high-yield bonds, which are debts of firms with weaker credit ratings, the Bank estimates the total stock of debt to riskier firms in Britain was worth about a fifth of all lending to UK companies.

In common with the US, it said lending terms had loosened in Britain and risk appetite among investors remained strong, with the proportion of maintenance covenants – designed to protect investors and ensure companies meet certain financial tests – dropping from nearly 100% of leveraged loans in 2010 to 20% at present.

“As with sub-prime mortgages, underwriting standards had weakened,” the FPC said, adding that it would assess the risks to British banks in the 2018 banking industry stress tests, the result of which is due in early December.

The rapid growth in high-risk lending comes as investors search for higher returns as a result of rock-bottom interest rates and billions of pounds of quantitative easing from central banks, used to stimulate their economies during the great recession that followed the 2008 financial crisis.

There are growing concerns that companies will be unable to repay their debts as central banks begin to raise interest rates 10 years on from the crash, including three hikes this year by the US Federal Reserve.

The FPC said there were key differences between US sub-prime mortgages and the leveraged loan market. Banks had substantial liabilities connected to sub-prime, it said, which was the reason many required bailouts during the 2008 financial crisis, which was not the case for leveraged loans. It also said there were limited complex financial products connected to the issuance of leverage loans.

Leveraged loans are not typically held by banks because they package them up and sell them on to third-party investors, such as the loan funds of major investment management companies. Banks do, however, retain some risk, particularly if they have a pipeline of risky loans that they have not sold on.'

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Leveraged Loan Market Warnings Have Been Ignored For Over Five Years

Former Federal Reserve Chair Janet Yellen expressed her concerns about the significant growth of covenant-lite leveraged loans in an interview with Mr. Sam Fleming of The Financial Times. Yesterday, she stated “I am worried about the systemic risks associated with these loans. There has been a huge deterioration in standards; covenants have been loosened in leveraged lending.”

And now over five years later, the leveraged loan market in the U.S. is over $1.3 trillion. When an economic downturn begins, covenant-lite loans, which are over 70% of the leveraged loan market in the U.S., are at higher risk of default than other similar loans because lenders have fewer protections.  Not only are banks at risk when they hold these loans on their balance sheets, but so are a wide array of global investors, such as pension funds, insurance companies, and asset managers, to whom banks transfer the risk in the form of collateralized loan obligations (CLOs) which are disproportionally backed by leveraged loans.

https://www.forbes.com/sites/mayrarodriguezvalladares/2018/10/26/leveragedloanmarketwarningshavebeenignoredforoveriveyears/

Yep, looks like we'll hear more about this.

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