BEVERLY HILLS, Calif, May 1 (Reuters) - Bankers and investors who use leveraged loans to fuel deals were bullish on the market's prospects at a conference this week, shrugging off concerns that lax underwriting or rapid growth poses a threat to the financial system.
The U.S. Federal Reserve's decision to stop raising interest rates helped reverse a downturn in the leveraged-loan market that began in late-2018, major players said at the Milken Global Conference in Beverly Hills. As investors look for high yields, leveraged loans packaged into securities can offer an attractive risk-return, they said.
"Leveraged loans, by and large, are cheap and a very good place to invest capital," David Miller, global head of credit at Credit Suisse, told a panel at the conference.
Leveraged loans tend to be used by private equity firms to fund acquisitions of highly indebted companies with weak credit ratings. Banks fund the loans and then package them into securities known as collateralized loan obligations, or CLOs. Insurers, pension funds, wealthy individuals and other investors buy portions of those securities.
The leveraged lending market has grown to over $2 trillion in the United States, according to credit rating agency Moody's. That is up about 80 percent over the past eight years, making the leverage loan market bigger than the junk-bond market.
The expansion has been fueled by a combination of low interest rates since the 2008 financial crisis and a booming U.S. economy.
As demand has strengthened, underwriting standards have slipped. Deals tend to have higher ratios of debt-to-earnings, and often feature "covenant-lite" terms, meaning investors in CLOs have fewer protections if a borrower defaults.
Some credit analysts and financial regulators have expressed concerns, warning that leveraged loans could pose a threat to financial stability. That is especially true, they have said, if the United States faces an economic slowdown.
"It's been a systemic risk for a long time," said Moody's analyst Andrea Usai. "Most of the risk is with the non-banking sector, but banks are part of a very connected financial system and if there were a problem it could ultimately hurt them."
Banks are exposed both through their direct lending to companies and their funding of non-bank lenders, Usai said in an interview.
Worries about how a leveraged-loan downturn would affect the banking industry intensified after the Trump administration eased leveraged-loan standards for big banks last year. Lenders may need several months to offload exposure, which puts them at risk if the market freezes up.
JPMorgan Chase & Co and Bank of America Corp are the biggest providers of leveraged loans among U.S. banks, with each boasting market share of 11 percent, according to credit ratings agency DBRS. Wells Fargo & Co is close behind with 8 percent market share, while Goldman Sachs Group Inc and Barclays PLC have smaller, but rapidly growing shares.
As fears about a potential U.S. recession percolated toward the end of 2018, the market for funding and selling leveraged loans all but dried up. Total leveraged lending in the final quarter of 2018 fell to more than a 2-1/2-year low, according to S&P Global Market Intelligence.
But as the Fed adopted a more dovish stance on fiscal policy, the market heated up again. CLOs arranged this year in the United States totaled $39.4 billion through April 19, in line with the $38.7 billion sold during the same period last year, according to data from LPC, a unit of Refinitiv.
Milken conference attendees who are active in leveraged loans said the market can withstand a downturn, pointing to strong performance during the global financial crisis a decade ago.
"There were no problems then and that was during the worst time in history," Blackstone Group LP Chief Executive Stephen Schwarzman told Reuters.
Others were less certain about long-term performance, especially given a deterioration in underwriting standards, but felt the returns are too strong to ignore.
"They'll behave well over the next three to five years," said Michael Hintze, chairman of the asset-management firm CQS. "Whether they'll behave well over the next 10 years, we'll see." (Reporting by Matt Scuffham. Editing by Lauren Tara LaCapra and Steve Orlofsky)