Private credit firms and collateralised loan obligation managers have had a rough few months in the public eye, with leveraged lending drawing parallels to the mortgage market meltdown that was at the root of the global financial crisis.
The IMF, Bank of England chairman Mark Carney and US senator and presidential candidate Elizabeth Warren, have been powerful critics of the rise in leveraged loans. However, credit managers have a powerful ally in US Federal Reserve chair Jerome Powell, who has signalled he does not think they pose an imminent danger – at least for now.
“In public discussion of this issue, views seem to range from ‘This is a rerun of the subprime mortgage crisis’ to ‘Nothing to worry about here.’ At the moment, the truth is likely somewhere in the middle,” Powell said earlier this week at a conference in Florida sponsored by the Federal Reserve Bank of Atlanta.
Credit managers consistently maintain the leveraged loan market does not pose a massive threat to the economy.
Another argument they make is that they oversee “patient capital” due to the extended nature of locked-up money, to say nothing of permanent capital sources like business development companies. And Powell agreed with that assessment.
“CLOs, which have facilitated the growth of leveraged loans, have stable funding: investors commit funds for lengthy periods, so they cannot, through withdrawals, force CLOs to sell assets at distressed prices,” he said.
Powell drew an important caveat in his speech, however: a weakening economy could spell trouble for companies with massive debt loads, much of which comes in the form of leveraged loans.
“If a downturn were to arrive unexpectedly, some firms would face challenges. Not only is the volume of debt high, but recent growth has also been concentrated in the riskier forms of debt,” he said, noting the growth in securities with a triple-B rating, the lowest investment grade status, and the boom of non-investment grade debt.
“Investors, financial institutions, and regulators need to focus on this risk today, while times are good,” Powell concluded.