Moody's: Leveraged Loan Market Creating Risks For US Banks

Those who don't learn from history are doomed to repeat it, and Moody’s Investors Service issued a warning to investors on Wednesday that U.S. banks are entering territory not seen since prior to the 2008 financial crisis.

Moody’s said U.S. corporate leverage now exceeds levels seen prior to the financial crisis, creating direct and indirect risks for American banks. Fortunately, Moody’s associate managing director Andrea Usai said banks are much better-positioned to handle these risks than they were in 2008.

“US banks' healthy earnings and strong capital buffers should be adequate to absorb the direct risks from leveraged loans on their books and their holdings of collateralized loan obligations,” Usai wrote Wednesday.

Indirect Risk

Still, Moody’s cautioned that if economic conditions in the U.S. were to materially worsen leveraged lending exposure “would rise appreciably” and potentially create indirect risks for banks. Moody’s said a collapse of the leveraged loan market could spill into other loan markets or asset classes.

The U.S. leveraged loan market has ballooned to an all-time high of $2 trillion thanks to favorable credit conditions in a booming economy. Banks hold only a small fraction of the outstanding leveraged loans and are generally much healthier thanks to post-crisis regulations such as the Dodd-Frank Act requiring banks to have access to more liquid capital on their balance sheets. In May 2018, President Donald Trump signed a bill rolling back many of the Dodd-Frank regulations on banks with less than $250 billion in assets.

Red-Hot Bank Stocks

Big banks are off to a hot start to 2019, suggesting investors aren’t particularly concerned about the leveraged loan market at this point. Here’s a look at how some key investments are performing year-to-date:

• Wells Fargo & Co WFC is up 7.4 percent.
• JPMorgan Chase & Co. JPM up 7.7 percent.
• Bank of America Corp BAC up 18.2 percent.
• Goldman Sachs Group Inc GS up 18.8 percent.
• Citigroup Inc C up 23.8 percent.
• Financial Select Sector SPDR Fund XLF up 11.1 percent.

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