Financial crises take about a decade to be born. Having lived through four of them, I see the raw materials for a fifth one — flowing from the collapse of so-called leveraged loans — debt piled on top of companies with weak credit ratings.
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I think leveraged loans rhyme with junk bonds and subprime mortgages. Banks make leveraged loans “to companies that have junk credit ratings in the hope of quickly selling the debt to investors, including mutual funds, hedge funds and entities called collateralized loan obligations,” according to the New York Times.
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Since the end of 2008, Thomson Reuters calculates that corporations have used them to borrow a whopping $4.6 trillion. Leveraged loans are slowing down. Last year, companies used them to borrow $940 billion but so far in 2015, they’ve taken on a mere $700 billion worth of that debt, according to Thomson Reuters. And more borrowers are not paying up. In September, Fitch Ratings forecast that leveraged loan default rates could approach 2% by the end of 2015, after five August defaults totaling $1.4 billion.
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Citing anonymous sources — usually a sign of fear — the Times estimates that banks will take $600 million in losses from leveraged loans that they’re holding on their books that nobody wants to buy.