17 October 2018

Financial Times: BoE warns over growth of risky corporate loans

The number of loans made to risky companies by banks and other non-bank lenders has exploded globally, with the BoE noting “rapid growth” driven by investor demand.

While the US is leading the $1.3tn global market in so-called leveraged loans, the UK is not far behind, with a record £38bn of such loans issued in Britain last year by shadow banks alone.

A further £30bn has already been issued this year, the BoE said. The BoE defines a leveraged loan as one made to a company whose debt is more than four times its earnings, before interest and tax deductions.

Of particular concern to the BoE is that lending terms are loosening with the rise of so-called covenant-lite loans, which lack key protections banks traditionally demanded to lend to riskier companies. While all loans had a full package of these protections eight years ago, 80 per cent of deals are now covenant-lite, according to the BoE.

“The global leveraged loan market was larger than — and was growing as quickly as — the US subprime mortgage market had been in 2006,” reads the BoE’s record of the most recent meeting of its Financial Policy Committee. The FPC is tasked with spotting and trying to mitigate risks to the UK’s financial stability.

“As with subprime mortgages, underwriting standards had weakened, there was significant uncertainty around the ultimate investors in collateralised loan obligation securitisations and hence their capacity to absorb losses, and borrowers would face higher financing costs if interest rates or credit spreads increased.”

The BoE said it would assess the risks of leveraged loans to bank balance sheets in this year’s round of stress tests, the results of which are due in early December. It will also study the increasing role of non-bank lenders, which are often less heavily regulated.

The BoE’s warning follows a similar one from the International Monetary Fund, which earlier this year said the loans were a potential source of financial instability.

Full article on Financial Times (subscription required)

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