September 26, 2019 - Article updated on October 3, 2019. An analyst at American Family Insurance concluded in a recent report that leveraged loans do not pose a systemic risk at this time.* The report, authored by Steven Kelly and shared with the LSTA, is a response to press and regulatory inquiries into this question such as the Bank of International Settlements’ report released on Sunday.
After evaluating most of the various questions related to this issue, the report concludes that while credit risk has increased, current trends flagged by market critics do not indicate systemic risk, consistent with the LSTA’s position.
Among the noteworthy points in the report are that:
- While covenant quality has deteriorated, it remains at levels normally seen in the high-yield bond market, indicating that overall covenant quality in leveraged debt markets has not deteriorated markedly.
- In contrast to the pre-crisis CDO market, there is little-to-no activity in the market for derivative-based “amplifiers” such as synthetic credit default swaps or risky structured finance CLOs that could spread the effects of a negative shock to other markets.
- The leveraged loan market remains well-diversified across all sectors. Thus, while individual deals may turn out to be of dubious financial strength, there is no evidence of “real” malinvestment on a macroeconomic level emanating from the leveraged lending sector.
The report is a welcome addition to the growing body of evidence that a downturn in leveraged loans would remain relatively contained to that market.
* The report reflects the views of the analyst and not those of his employer.