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Highly leveraged companies are borrowing more money at a furious pace, which has led the US Federal Reserve to consider this trend as a potential risk to the financial system.
Business loans with large outstanding amounts, known as leveraged loans, increased by 20% in 2018 to reach $ 1.1 trillion, according to the Fed's twice a year financial stability report. The share of large new loans to relatively risky borrowers now exceeds the record levels previously achieved in 2007 and 2014.
Defaults on these loans remain low, but the Fed has warned that this could change if the economy weakens.
Risks associated with leveraged borrowings have "intensified, with a greater proportion of them going to borrowers with lower credit ratings and already high levels of debt", according to the report of the Bank. Fed released Monday. "Any weakening of economic activity could increase default rates and lead to credit contractions affecting the employment and investment of these firms."
This is not the first time the Fed warns of corporate risk loans. The central bank said in its November report that leverage loan standards were deteriorating, and Dallas Central Bank Federal Reserve Chairman Robert Kaplan wrote in an essay published earlier this year that corporate debt could "amplify" any slowdown in US growth.
"In the next downturn, I think this amount of corporate debt will be a burden," Kaplan said in an interview.
Leveraged loans have increased in part because the economy is strong and interest rates low.
Investors are willing to hold riskier debts because they earn more while the interest rates on the safest assets are very low.
The loans are either held by mutual funds, which group the funds of many different investors, or are pooled and used to secure securities called secured loan obligations. These are sold to banks, mutual funds and other investors – asset managers, insurance companies and hedge funds claiming the riskiest shares.
The swelling of corporate debt at risk may seem similar to the mortgage-backed security boom that fueled the 2008 financial crisis, but the Fed's report indicates that the situations are different. The Fed said secured loan bonds are structured more securely than their parents backed by housing, and that banks should be able to manage their exposure to corporate debt.
Nevertheless, the central bank does not seem particularly confident about the impact of a possible economic crisis on the leveraged loan sector.
"It is difficult to know for sure how c. structures and investors would come out in a period of prolonged stress, "the report says.
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