Bank of England warns on boom in lending to indebted firms
The growth of new lending to already debt-burdened borrowers has parallels to the subprime mortgage boom which ended with the global financial crisis, according to minutes from a discussion by Bank of England’s top financial stability policymakers.
Minutes published today from the financial policy committee (FPC) showed that members, who include Bank of England governor Mark Carney, “discussed the extent to which the growth in leveraged loans had parallels to the growth in the US subprime mortgage market before the crisis”.
So-called leveraged loans, in which borrowers take on more debt, carry a higher credit risk for the lender, but also offer a higher return in parallel, at a time when investors are searching for yield.
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In the US the size of the leveraged loan market is now above $1 trillion, compared to $8 trillion in total corporate debt. In the UK non-financial companies had issued a record £38bn in leveraged loans in 2017 and £30bn already in 2018.
The Bank also highlighted the rise in loans with weaker covenants attached. So-called covenant-lite debt give lenders less power to call a loan in.
“Risks from the US corporate sector remained material”, the FPC minutes said.
“The global leveraged loan market was larger than – and was growing as quickly as – the US subprime mortgage market had been in 2006.”
The FPC highlighted weaker “underwriting standards” and “significant uncertainty around the ultimate investors in collateralised loan obligation securitisations and hence their capacity to absorb losses”. Similar features heightened the boom before the financial crisis, before a rising number of defaults triggered panic among the holders of the hard-to-value instruments.
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However, the FPC did not that a mitigating factor is that the loans were not financed by short-term borrowing and the market for securitisation – packaging multiple loans up into bundles to sell on – is also smaller.
The minutes also reiterated the Bank’s position that EU authorities must ensure clearing houses can continue to function even if there is a no-deal Brexit. Overall the FPC judged that the UK has done everything it can to control the risks from the Brexit process.
“There had been considerable progress in the UK to address these risks, but only limited progress in the EU,” the minutes read. “The need for authorities to complete mitigating actions was now pressing.”
Risks other than Brexit remain at a “standard level”, the minutes said.
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