NEW YORK, June 4 (LPC) - Ten years out from the financial crisis and legislators and regulators are sounding the alarm about risks in the US$1.2trn leveraged loan market, concerned that loosening lender protections and aggressive terms in the asset class could weigh on the overall US economy.
On Tuesday, a Congressional committee will discuss risks in leveraged lending with a panel of professors as the credit crisis and high-profile bankruptcy filings including Toys ‘R’ Us, the well-known toy store that encouraged everyone to be a Toys ‘R’ Us kid, weigh on committee members’ minds.
“In 2008, we went through the greatest financial crisis since the Great Depression and I don’t want to ever get back there and do that again,” said US Representative Gregory Meeks, who chairs the House Financial Services subcommittee overseeing the hearing.
The 2017 bankruptcy filing of Toys ‘R’ Us was a warning sign for the New York Democrat.
“It’s a question as to whether a bubble can build when you are lending to companies that are already deeply in debt; what happens if you have multiple Toys ‘R’ Us all at one time,” Meeks said in a telephone interview. “That was the question I had about whether that would then create a systemic risk.”
Years of low interest rates coupled with increasing demand for floating-rate loans has seen the asset class more than double in size since the credit crisis, allowing companies to borrow higher levels of debt compared to their earnings than in the past while offering fewer lender protections in return.
The aggressive underwriting has drawn rebukes from former Federal Reserve (Fed) Chair Janet Yellen and Senator Elizabeth Warren, but current regulators including Randal Quarles, vice chair for supervision at the Fed, have tried to tamp down on concerns that leveraged lending could present a systemic risk.
Ahead of the hearing, the Subcommittee on Consumer Protection and Financial Institutions released draft legislation for potential bills legislators say could improve oversight of the leveraged lending market and mitigate risks to financial stability.
The Leveraged Lending Data and Analysis Act would require the Office of Financial Research (OFR), in coordination with Financial Stability Oversight Council (FSOC) member agencies, to gather information on leveraged lending and Collateralized Loan Obligations (CLOs), the largest buyers of leveraged loans, and assess the risks these transactions may pose to the US economy. The OFR would then issue semi-annual reports describing its findings to FSOC and Congress.
The Leveraged Lending Examination Enhancement Act would require the Federal Financial Institutions Examination Council (FFIEC) to establish uniform examination procedures for bank regulators to oversee leveraged lending activity and direct regulators to issue quarterly reports analyzing leveraged lending risk management.
A separate discussion draft for protecting the independent funding of the OFR is sponsored by Representative Bill Foster, a Democrat from Illinois, which would give the OFR director sole discretion of its annual budget.
Additional hearings on leveraged lending may be warranted, and additional discussions with regulators, in private or in public, may be needed, Meeks said.
“We need to look to discover where the risk may be before the fact,” he said. “We found out too late in the fiscal crisis of 2008.” (Reporting by Kristen Haunss. Editing by Leela Parker Deo and Jon Methven)