Europe’s banking regulator fears that heavily indebted borrowers will begin to struggle to service their debt as the economy slows, costs rise and interest rates rise.
Leveraged finance has exploded in Europe and elsewhere in recent years as central banks free up cheap money to propel economic growth.
Although emissions have slowed this year due to the war in Ukraine, the European Central Bank (EBC) estimates that more than 4 trillion dollars of these outstanding loans in the world, notes the Wall Street Journal.
The ECB says the leveraged loan exposures of 28 banks it supervises, including some US banks, increased by 80% between 2018 and last year to reach 500 billion euros, the equivalent of $530 billion.
This represents 60% of their combined key capital ratio, which could evaporate if defaults become widespread. Leveraged loans typically have borrowing costs that float, making refinancing more expensive.
Last year, Deutsche Bank AG comics said it levied an additional capital charge on leveraged loans in accordance with ECB instructions.
The bank said revenue from leveraged loans dragged down its investment banking business in its quarterly results.
After Russia invaded Ukraine in late February, the leveraged loan market ground to a halt, S&P said. It resumes. Privately, banks balked at the ECB’s assessment, saying it overestimated the problem. For example, it includes undrawn credit lines in its exposure.
According to WSJ, Fitch Ratings, which tracks leveraged loans to rated companies, said borrowers have so far shown resilience. He expects default rates to rise to 2.5% in 2022 from 0.5% in the past 12 months to March.
Photo by Gerd Altman