FSB published a report that assesses the financial stability implications of developments in the leveraged loan and collateralized loan obligations (CLO) markets. The report first provides an overview of the leveraged loan and CLO markets and describes recent developments in these markets. It then discusses the potential vulnerabilities inherent in leveraged lending and the securitization of these loans, before finally assessing the possible financial stability implications. The report provides a global perspective by combining available data and analyses from FSB members.
Markets for leveraged loans and CLOs have grown significantly in recent years, with the majority of issuance concentrated in the U.S. and to a lesser extent the in EU. The securitization of leveraged loans through CLO issuance, which had come to a halt almost entirely between 2009 and 2010, exceeded the pre-crisis levels in 2014 and has remained strong since then. While most leveraged loans are originated and held by banks, and banks have the largest exposure to the market, the role of non-bank financial institutions has increased. The report concludes that:
- Vulnerabilities in the leveraged loan and CLO markets have grown since the global financial crisis. Borrowers’ leverage has increased; changes in loan documentation have weakened creditor protection; and shifts in the composition of creditors of non-banks may have increased the complexity of these markets.
- Banks have the largest direct exposures to leveraged loans and CLOs. These exposures are concentrated among a limited number of large global banks and have a significant cross-border dimension.
- A number of non-bank investors, including investment funds and insurance companies, are also exposed to the leveraged loan and CLO markets.
- Given data gaps, a comprehensive assessment of the system-wide implications of the exposures of financial institutions to leveraged loans and CLOs is challenging.
As at December 2018, banks have the largest direct exposure to leveraged loans and CLOs. This is not surprising, as banks fulfill various roles in, and are a critical component for the functioning of, these markets. Both public and supervisory data indicate that banks’ exposure to leveraged loans and CLOs is highly concentrated in a limited number of global systemically important banks (G-SIBs). According to supervisory data, as of end 2018 banks in the Euro Area, Japan, UK, and U.S. are estimated to have direct exposures of nearly USD 1.368 trillion to leveraged loans through credit facilities, typically in the form of drawn and undrawn revolvers. Of this amount, USD 760 billion is held by U.S. banks, USD 348 billion by Euro area banks, USD 140 billion by Japanese banks, and the remaining USD 120 billion by UK banks.
Using supervisory and market data, the report identifies the direct holders of roughly 79% of leveraged loans and 86% of CLOs. Little is known, however, about the direct exposures of certain non-bank investors to these markets. Including their holdings of lower-rated CLO tranches. FSB will consider whether there is scope to close data gaps, will continue to analyze the financial stability risks, and will discuss the regulatory and supervisory implications associated with leveraged loans and CLOs.
Keywords: International, Banking, Insurance, Securities, G-SIB, Financial Stability, Leveraged Lending, Collateralized Loan Obligations, FSB
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