W when a financial risk expert in one of the world's most powerful private equity instruments tells investors to scale down their exposure to a specific corner of the debt market, it is worth noting.
Henry McVey, who is part of the KKR risk committee, said last week that the leveraged loan market – an amount of $ 1
McVey is not alone in his caution. A growing chorus of global leaders has spent 2018 warning that the mountain of indebted loans was becoming dangerously large and calling for confrontations with the financial crisis a decade ago.
The Bank of England, the Central Bank of Australia, the International Monetary Fund and members of the United States The Federal Reserve has raised red flags on so-called leveraged loans, offered to companies already in debt, but often with few restrictions .
In October of last year, the Bank's financial policy committee, which monitors the health of the financial system, raised the specter of the 2007-08 credit crunch. He said that "the global leveraged loan market was bigger than – and was growing rapidly – the subprime mortgage market in the United States had been in 2006".
As with the subprime crisis, the bank added, the underwriting standards had slipped – in other words, the risky corporate debt was too easy to obtain right now. "Given the decline in underwriting standards, investors in leveraged loans increase the risk of loss," said the Bank.
The key question now is whether a bubble in a different corner of the debt market can trigger the market panic. "A quote wrongly attributed to Mark Twain fits here: history rarely repeats itself, but rhymes," said Rasheed Saleuddin, an associate researcher at the Judge Business School of the University of Cambridge.
While saying that it was difficult to see the next The financial collapse resulting directly from a failure in the leveraged loan market, Saleuddin added that there was the possibility that "small changes in loan default rates or even their expectations could cause a collapse ".
In the 2008 financial crisis lead-up, banks were so eager to lend that they freely distributed mortgages to customers with weak or non-existent credit histories that ended up defaulted when times became difficult. Those mortgages had been grouped and turned into investable products, causing a chain reaction of losses that spread to oil spills across the financial system and caused a global recession.
A decade later, rather than distributing risky loans to homeowners, banks are distributing indebted loans to indebted companies. Many are also "covenant-lites", in the sense that they are provided with less constraints for borrowers and, consequently, present a greater risk for creditors.
But since most of the loans are sold and bundled as collateralised bonds, or CLO, there they are less incentives to impose strict terms. Loaned loans also have floating rates, making them more attractive to investors, who receive higher interest payments when rates increase.
Amir Amel-Zadeh, an associate professor at the Saïd Business School of the University of Oxford, explained that investors in leveraged loans, mutual funds and CLOs could face greater losses than investors in the same products during the 2008 crisis due to the reduction of loan standards, an increase in covenant-lite loans and higher levels of corporate indebtedness compared to 10 years ago.
trends in the CLO market were similar, he said that in 2008 the scale was not at all close to the mortgage securitization market – about a tenth of the size. "So at first glance it's not so worrying from a systemic risk perspective, but if economic conditions worsen, it can lead to losses for many investors and lead to a similar liquidity dry-up in these instruments as we've seen with securitization of subprime mortgages during the 2008 crisis. "
Reports have already shown that the CLO market may be cooling down, as uncertainty grips the financial markets. With fewer investors lining up to take a slice of the leverage market, prices have declined and banks have postponed leverage to investors as a result. "If banks have to keep the loans on their books they will be exposed to price risk," Amel-Zadeh said
Without a hungry market to sell leveraged loans, banks may be less willing to lend themselves so liberally to borrowing companies . And without additional loans to feed their debt habits, companies could be at risk of default. This particular debt market will be one to keep an eye on in 2019.