WASHINGTON–The Federal Reserve has flagged as a risk to watch the growing amount of corporate debt at some companies.
Loans to companies with large amounts of outstanding debt, known as leveraged lending, grew by 20% in 2018 to $1.1 trillion, according to the Fed’s most recent Financial Stability Report, reported the New York Times. The share of new, large loans going to the comparatively risky borrowers now exceeds peak levels reached previously in 2007 and 2014, the Times report added.
While the Fed noted defaults on these loans remain low, that could change if the economy should falter.
Risks associated with leveraged loans have “intensified, as a greater proportion are to borrowers with lower credit ratings and already high levels of debt,” according to the Fed report. “Any weakening of economic activity could boost default rates and lead to credit-related contractions to employment and investment among these businesses.”
Not the First Warning
The Times noted this is not the first time the Fed has warned about risky corporate borrowing. The central bank mentioned in its November report that leverage loan standards were deteriorating, and Federal Reserve Bank of Dallas president, Robert Kaplan, wrote in an essay earlier this year that corporate debt could “amplify” any slowdown in United States growth.
“In the next downturn, I think this amount of corporate debt is going to be a burden,” Mr. Kaplan said in an interview with the Times.
Leveraged lending has increased in part because the economy is strong and interest rates are low, according to the Times analysis, which added investors are willing to hold riskier debt because it pays more at a time when interest rates on safer assets are very low.
‘Situations Are Different’
“Ballooning levels of risky corporate debt may seem to have parallels to the mortgage-backed security boom that helped fuel the 2008 financial crisis, but the Fed report said the situations are different,” the Times reported. “The Fed said the collateralized loan obligations are structured in a more secure way than their housing-backed relatives, and banks should be able to handle their exposure to corporate debt.”