Leveraged Credit Is a Growing Risk for US Banks

Growing Risk for US Banks: The corporate credit market is going through challenges. This market involves businesses borrowing money by issuing bonds and taking loans. Right now, there are some problems like interest rates going up, inflation persisting, and the economy being uncertain. Because of these issues, U.S. banks could face more risks. This information comes from a report by the Federal Deposit Insurance Corp. (FDIC), which is a government agency that oversees banks.

Leveraged Credit Is a Growing Risk for US Banks

The big banks have a lot of connection to the corporate credit market. This is because they have invested in different types of loans and bonds that businesses use to get money. However, the conditions for lending to businesses have become worse in the past year and a half. This is mainly because of high inflation (which means prices are rising fast), higher interest rates, and not knowing how the economy will do in the future.

An expert named Boaz Weinstein, who works at Saba Capital Management, said that if borrowing stays tough like this, it’s very likely that more businesses will struggle to pay back their loans. This is called a “default,” and it’s a problem for both the businesses and the banks.

Businesses issuing corporate bonds (which are like IOUs that they sell to investors) have been doing it less lately. This happened after the Federal Reserve, which is like the U.S. government’s bank, started making interest rates higher to control inflation. When interest rates go up, borrowing becomes more expensive. This means companies don’t want to borrow as much.

Banks give loans to companies with different levels of creditworthiness. Some companies are seen as safer to lend to (they have “investment-grade” credit), and others are seen as riskier (they have “high-yield” or “subpar” credit). Lending to riskier companies went down a lot, by 80%, while lending to safer companies went down by 15%.

Although there’s a risk that the corporate credit market issues could make banks less stable, the FDIC says that U.S. banks have been strong so far.

There are a couple of positive things that help. Some borrowers took advantage of low interest rates when the pandemic started to refinance their loans. This means they extended the time they have to pay back the loans. Also, the difference in returns between corporate bonds and safe U.S. government bonds isn’t too high. This shows that investors are not too worried about businesses failing to pay back.

The biggest risk is with “leveraged loans.” These are loans given to companies that already owe a lot of money. These loans have changing interest rates, which can make it harder to pay back over time. The main danger here is that the companies might not be able to repay their loans. These types of loans increased to $1.1 trillion last year, but the growth rate slowed down.

Banks also have “syndicated loans,” which are loans given to companies by a group of banks. These include leveraged loans. Banks’ holdings of these loans went up by 20% in the last quarter of the year. Additionally, there’s something called “collateralized loan obligations” (CLOs), which are like packages of loans. The four biggest banks have a lot of these, and they went up by 13% in the first quarter of this year.

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