BoE warns that growth in leveraged loans is parallel to sub-prime

The growth of new lending to those already in debt has “parallels” to the sub-prime mortgage boom which resulted in the financial crisis, according to the minutes from a discussion by the Bank of England’s (BoE) top financial stability policy-makers.

Minutes published yesterday from the financial policy committee (FPC) revealed that members, including BoE governor Mark Carney, “discussed the extent to which the growth in leveraged loans had parallels to the growth in the US sub-prime mortgage market before the crisis”.

The so-called leveraged loans, in which borrowers (usually those with poor credit) take on more debt, carrying a higher credit risk for the lender, but as a result offers a higher return, at a time when investors are searching for a yield.

The FPC minutes noted: “Risks from the US corporate sector remained material.

The committee highlighted weaker “under writing standards” and “significant uncertainty around the ultimate investors in collateralised loan obligation securitisations and hence their capacity to absorb losses”. Similar aspects strengthened the boom before the crisis it, before an increasing number of defaults triggered panic among the holders of the hard-to-value instruments.

In the United States (US), the size of the leveraged loan market is now above $1trn (£760bn), compared to $8trn in total corporate debt. Furthermore, gross debt for firms in the US increased from 254 per cent of annual earnings at the start of 2015 to 290 per cent in the spring of 2018, which the FPC said was “close to 2007 levels”.

However, in the UK, non-financial companies issued a record £38bn in leveraged loans in 2017, and have already issued £30bn in 2018. Currently a fifth of UK corporate sector debt is held by riskier firms which do not make the “investment grade” rating.

The BoE will assess the implications of the rise in leveraged loans for the banking sector in its stress test this year.

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