Leverage loans do not present major risk, according to GAO

Leverage loans do not pose a major risk to U.S. financial stability, but financial regulators remain cautious, according to a GAO report released on Wednesday.

Based on comparisons between regulators and others with the pre-2008 subprime mortgage market, the GAO report examined whether loan origination and securitization could spread a similar risk, particularly during the Covid-19 pandemic.

Before the pandemic, the Financial Stability Supervisory Board and other regulators found that riskier borrower profiles and more flexible underwriting standards left players in the leveraged loan market vulnerable to loss in the event of a risk. slowdown. After March 2020, loans suffered record downgrades and an increase in defaults, but top-rated CLO securities remained resilient and, in September, leveraged loans did not pose significant threats to financial stability. , according to the report.

Unlike the previous financial crisis, CLO securities appear to pose less risk with better investor protections, better insulation against market fluctuations and fewer links to other risky and complex instruments, according to the report.

“According to regulators’ assessments, leveraged lending activities have not contributed significantly to the distress of a large financial entity whose failure could threaten financial stability. and other investors seemed manageable as well, ”the report said, and mutual funds subject to investor redemptions were able to cope, in part, by selling holdings of leveraged loans.

The report recommended that the FSOC “better prepare against threats to stability” by asking its chairman, the Secretary of the Treasury, to conduct crisis scenario exercises. In addition, Congress should consider legislative changes to strengthen the authority of the FSOC, steps FSOC officials have said they will take if necessary.

According to the report, the market for leveraged institutional loans – business loans to heavily leveraged companies – grew to $ 1.2 trillion in 2019, from an estimated $ 500 billion in 2010, fueled largely by investor demand for CLO securities offering a return rate.

Drew Maloney, chairman and CEO of private equity advocacy group American Investment Council, said the GAO report highlighted the role of the private credit market. “Throughout the COVID-19 crisis, we have seen how businesses of all sizes across the country have relied on private credit to keep their doors open and their workers employed,” Maloney said in a statement. press release sent by email.