Big Banks Are Very Exposed To Leveraged Lending And CLO Markets

via forbes:

By no means are banks immune to any downturn in leveraged lending. As pointed out in a very detailed research piece last week by Standard and Poor’s LCD News, “Banks and hedge funds, which over the past few years have taken a back seat to collateralized loan obligations and other institutional investors in the $1.19 trillion U.S. leveraged loan market, have regained market share in recent months amid a rockier, more risk-off environment.”

Banks are very exposed to leveraged loans in several ways. For example, banks:

  • have leveraged loans on their books which they have underwritten,
  • provide loans and a wide range of credit lines to non-banks who use those funds to underwrite leveraged loans to a wide range of companies and financial institutions,
  • buy 50% of the collateralized loan obligations (CLOs), many of which contain leveraged loans,
  • provide loans and a wide range of credit lines to insurance companies, pension funds, university endowments and other investors that buy collateralized loan obligations (CLOs), and
  • are counterparties to credit default swaps which banks and non-banks use to protect against leveraged loan or CLO defaults.

According to recent Bank for International Settlements data, leverage lending is now about $1.4 trillion, with about 71% of that lending underwritten in the U.S. In the U.S., leveraged lending is now higher than the amount outstanding of high yield bonds.

Additionally, the vast majority of leveraged loans are covenant-lite which means that if any of those borrowers default, both bank and non-bank lenders will have very little protection against loss severities.

Many banks and non-banks sell a good part of the leveraged loans on their balance sheets to a variety of funds and especially, to special purpose vehicles which package the loans and sell them as fixed income products called collateralized loan obligations (CLOs.)

New CLO issuance and total CLO volumes outstanding have continued to grow since I last wrote about this in November 2018. Since 2000, CLOs outstanding in the U.S. have grown from $72 to $616 billion, an almost 760% rise. That rise is significantly higher than that of total collateralized debt obligations (CDOs) outstanding in the US, which have risen 364% in the same time period, because there has been a significant decrease in other types of CDOs, such as structured finance CDOs.

 

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