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U.S. Fed Official Downplays Leveraged Loan Risks Amid Warnings of Potential Instability

May 10, 2019, 09:15 AM
Filed Under: Federal Reserve
Related: Federal Reserve

A top official at the U.S. Federal Reserve tempered warnings issued by the agency that record high levels of business debt coupled with deteriorating credit standards could "leave the business sector vulnerable to a downturn in economic activity or a tightening in financial conditions."

In a speech at Yale University following the release of the the Fed's latest Financial Stability Report [VIDEO], Randal Quarles, vice chair for supervision of the U.S. Federal Reserve, acknowledged that the high volume of leveraged lending "does create issues that (are) worth thinking about" but “is not a direct analogue to the subprime lending from before the crisis.”

“The business credit is very high currently, but it always grows, it hasn’t grown to a level that’s inconsistent with historical precedent for this point on an expansion,” Quarles said.

According to the Financial Stability Report for May, released this week: "Debt owed by the business sector has expanded more rapidly than output for the past several years, pushing the business-sector credit-to-GDP ratio to historically high levels.

Overall, vulnerabilities stemming from total private-sector credit have remained at a moderate level relative to the past several decades . However, growth in business debt has outpaced GDP for the past 10 years, with the most rapid growth in debt over recent years concentrated among the riskiest firms.

"The sizable growth in business debt over the past seven years has been characterized by large increases in risky forms of debt extended to firms with poorer credit profiles or that already had elevated levels of debt," the report adds.

Meanwhile the report notes that credit standards for some business loans appear to have deteriorated.

"Credit standards for new leveraged loans appear to have deteriorated further over the past six months," the Fed said. "The share of newly issued large loans to corporations with high leverage— defined as those with a ratio of debt-to-EBITDA above 6—increased in the second half of last year and the first quarter of this year and now exceeds previous peak levels observed in 2007 and 2014, when underwriting quality was poor."

Read the report in its entirety here.

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