Leveraged loans echo pre-crisis subprime crash: BoE's Carney

LONDON (Reuters) – Bank of England Governor Mark Carney on Wednesday likened the $2 trillion leveraged loan market to subprime mortgages that defaulted 10 years ago and triggered a global financial crisis, in a warning to British lawmakers.

Leveraged loans are made to companies that are highly indebted, and growth has been driven by investment funds and collateralized loan obligations (CLOs) linked to the loans.

“We are concerned just because the pace of growth has been quite rapid for some time,” Carney told the lawmakers.

“The subprime analogy… isn’t perfect, but it’s on the road to ‘no doc’ underwriting which happened 11 years ago.”

‘No doc’ refers to the lack of affordability checks on subprime home loans in the United States before the crisis.

Last year the BoE tested British banks’ exposure to leveraged loans by applying shocks that were greater than those seen during the financial crisis, Carney said. All the banks passed.

The BoE first made similar warnings to Carney’s in its November Financial Stability Report, which was the subject of Wednesday’s hearing in the Treasury Select Committee in parliament.

London is Europe’s center for leveraged loans, boosting profitability of banks and bringing in foreign capital to help Britain fund its current account deficit.

“My personal sense is the market is undergoing an adjustment, there is greater focus on underwriting,” Carney said.

Richard Sharp, a member of the BoE’s Financial Policy Committee, said leveraged lending needed to be better managed, not banned.

“It’s not just all bad. It’s a source of major employment and profitability here. It lowers the cost of capital for investment,” Sharp said.

Debt based on U.S. subprime mortgages was tucked away in “shadow banks” in the run-up to the financial crisis, making it harder to assess exposures, said Alex Brazier, BoE executive director for financial stability.

Exposures at UK banks to leveraged loans is among the lowest in the world, accounting for about 1 percent of global stock of CLOs, and 1.5 percent of the major banks’ core capital buffers, BoE data showed.

“That is one of the big differences with subprime. Even if the growth rates look the same, the underwriting standards have some disturbing similarities… there is none of this shadow banking activity,” Brazier said.

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Fed leaves rates unchanged, says U.S. economy strong

WASHINGTON (Reuters) – The U.S. Federal Reserve held interest rates steady on Thursday but remained on track to keep gradually tightening borrowing costs, as it pointed to a healthy economy that was marred only by a dip in the growth of business investment.

Business investment can be a key to rising productivity and future growth, and the fact that it had “moderated from its rapid pace,” as the Fed said, was the only cautionary note in a policy statement that touted strong job gains and household spending, and a “strong rate” of overall economic activity.

“The labor market has continued to strengthen and … economic activity has been rising at a strong rate,” the U.S. central bank said, leaving intact its plans to continue raising rates at a gradual pace. The Fed has hiked rates three times this year and is widely expected to do so again in December.

The statement overall reflected little change in the Fed’s outlook for the economy since its last policy meeting in September. Inflation remained near its 2 percent target, unemployment fell, and risks to the economic outlook were still felt to be “roughly balanced.”

Policymakers, however, took particular note of the moderation in business investment, an important component of GDP that can spin off jobs as companies build new facilities, and raise productivity as they upgrade equipment and processes.

Boosting investment was one of the main objectives behind the Trump administration’s move to reduce the corporate tax rate as part of its restructuring of the tax code at the end of 2017.

After adding four-tenths of a percentage point to economic growth in the first six months of the year, lagging investment in “nonresidential structures” trimmed a quarter of a percentage point in the annualized growth rate for the third quarter.

Financial markets, which had expected the Fed to hold its benchmark overnight lending rate steady in the current range of 2.00 percent to 2.25 percent this week, ticked lower after the statement was released.

After a stock market rout in October and signs that both housing and business investment may be waning, some analysts expected the Fed to possibly signal doubt about its next rate increase.

Yet December still seems firmly in play.

“The only surprise here is that they weren’t more hawkish,” said Boris Schlossberg, managing director of foreign exchange strategy at BK Asset Management in New York. “There were a couple words that were more muted – that business investment had ‘moderated’ from its earlier pace. But apart from that they have not signaled any warning signs at all.”

U.S. stocks, which had rallied broadly on Wednesday after the results of the U.S. congressional elections, turned lower as the Fed’s statement offered no indication the central bank might slow the pace of its rate increases.

The dollar also weakened against the euro and yen and U.S. Treasury yields held near the day’s high. The 10-year Treasury note yield, a benchmark for both consumer and business borrowing costs, was 3.23 percent, around the highest since 2011.


Data released in late October showed the U.S. economy grew at a 3.5 percent annual rate in the third quarter, well above the roughly 2 percent annual growth pace the Fed and many economists regard as the underlying trend.

But Fed policymakers also have begun debating whether the economy has reached a plateau as the stimulus from the Trump administration’s $1.5 trillion tax cut package and increased federal spending begin to fade.

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The Fed’s policy statement did not explicitly take stock of the recent volatility in U.S. equity markets that led to the selloff in October, or address the possibility of a slowdown in global growth next year.

There were no updated economic forecasts released on Thursday and Fed Chairman Jerome Powell was not scheduled to hold a news conference.

The Fed’s policy decision was unanimous.

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