Credit cycle is deteriorating quickly

The sub-prime timebomb is back – this time companies are lighting the fuse

Leveraged loans are ringing alarm bells for regulators who fear a repeat of 2008’s mortgage disaster

When an expert in financial risk at one of the world’s most powerful private equity outfits tells investors to scale down their exposure to a specific corner of the debt market, it is worth taking notice.

Henry McVey, who sits on the risk committee at KKR, said last week that the leveraged loan market – a $1.3tn (£1tn) pile of risky corporate loans – had been on a “great run in recent years” but the firm was now cutting its exposure to the asset class to zero.

McVey is not alone in his caution. A growing chorus of global leaders spent 2018 warning that the leveraged loan mountain was getting dangerously large and inviting comparisons with the financial crisis a decade ago.

The Bank of England, Australia’s central bank, the International Monetary Fund and members of the US Federal Reserve have raised red flags over so-called leveraged loans, which are offered to companies already in debt but often come with few strings attached.

In October last year the Bank’s financial policy committee, which monitors the health of the financial system, pointedly raised the spectre of the 2007-08 credit crunch. It said the “global leveraged loan market was larger than – and was growing as quickly as – the US sub-prime mortgage market had been in 2006”.

As with the sub-prime crisis, the bank added, underwriting standards had slipped – in other words, risky corporate debt was too easy to get right now. “Given the decline in underwriting standards, investors in leveraged loans are at increasing risk of loss,” said the Bank.

 

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