Excessive leverage, which was at the root of the financial crisis in 2008 as well as the Asian financial crisis in 1997-1998, has resurfaced in the U.S. market.
Leveraged loan volumes are setting new records and nearing $1.4 trillion, making it larger than the $1.3 trillion high-yield bond market, according to Mark Zandi, chief economist of Moody’s Analytics. These loans, made to companies that already have considerable debt, have been increasing at double-digit rates over the past five years and about half have been securitized into collateralized loan obligations (CLOs).
It’s “much too early to conclude” that the nonfinancial businesses receiving leveraged loans “will end the current cycle in the way subprime mortgage borrowers did the previous one,“ writes Zandi in the latest outlook report from Moody’s Analytics. There are significant differences between these two loan types but the “the similarities are eerie,” says Zandi.
The leveraged loan market and junk bond market together, at $2.7 trillion, are near the size of the $3 trillion subprime mortgage market at its peak. Leveraged loans, like subprime loans, also have adjustable rates, which can be problematic for borrowers when rates rise as they did leading up to the financial crisis and are rising now on the short end.
In addition, writes Zandi, the most aggressive lending in the leveraged loan market is by private lenders outside the banking system and regulatory oversight, much like the most egregious subprime lenders before the financial crisis; and demand is so strong for these loans that lenders are easing their underwriting standards, much like they did just before the financial crisis blew up.