The Fed might not be raising rates, but it is again warning about Corporate America's reliance on leveraged loans.
Why it matters: An economic slowdown could create a sharp spike in defaults, affecting not just individual companies but also mutual funds that hold bank debt or leveraged loans themselves.
Per the central bank's latest Financial Stability Report:
The big picture: It's not just the aggregate numbers that worry central bankers. It's also the continued weakening of leveraged lending standards and covenants. For example, the share of large loans with debt-to-EBITDA ratios above 6x is now higher than during prior peaks in 2007 and 2014. Moreover, a Moody's index tracking the strength of leveraged loan covenants is at its lowest level since the index launched in 2012 — including a substantial rise in cov-lite loans.
The bottom line: That's a major contrast from 2008, in that the Fed in 2019 suggests these loans could create a severe bubble deflation rather than an all-out pop. But perhaps the biggest difference is that the Fed and others are actually sounding preemptive alarms. If things get messy this time, no one will be able to pretend they weren't warned.
Go deeper: The debt market is littered with risky loans
