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Warnings over Lending to indebted companies

  • 31/10/2018
  • Jane Bray

Earlier this month a meeting by the Bank of England’s Financial Policy Committee (FPC) was held to discuss concerns regarding the growth of new lending to already indebted firms, through leveraged-loans. They fear that there are parallels to the subprime mortgage boom which ended with the global financial crisis in 2008.

So-called leveraged loans, in which borrowers take on more debt, carry a higher credit risk for the lender, but also offer a higher return in parallel, at a time when investors are searching for yield. The US is leading the $1.3tn global market in so-called leveraged loans, with the UK not far behind. A record £38 billion of such loans were issued in Britain last year by shadow banks alone, with a further £30 billion issued so far this year.

Taken together with high-yield bonds, which are debts of firms with weaker credit ratings, the Bank estimates the total stock of debt to riskier firms in Britain was worth about a fifth of all lending to UK companies.

In common with the US,  lending terms have loosened in Britain and risk appetite among investors remained strong, with the proportion of maintenance covenants – designed to protect investors and ensure companies meet certain financial tests – dropping from nearly 100% of leveraged loans in 2010 to 20% at present.

“As with sub-prime mortgages, underwriting standards had weakened,” the FPC said, adding that it would assess the risks to British banks in the 2018 banking industry stress tests, the result of which is due in early December.

Minutes from the FPC’s latest meeting also reveal warnings over the rise in loans with weaker covenants attached, and that EU authorities must ensure clearing houses can continue to function in the event of a no-deal Brexit: “There had been considerable progress in the UK to address these risks, but only limited progress in the EU,” the FPC asserted.

With businesses borrowing more money and taking higher financial risks it is more vital than ever to run credit reports on all the companies you deal with to reduce the risk of bad debt.

Sources: Connect/