Growing corporate debt echoes 2008 crisis

A risky corporate debt splurge is ­raising echoes of the financial crisis. Photo / 123RF

A risky corporate debt splurge is ­raising echoes of the financial crisis, the Bank of England fears, as officials scour the market for signs that a debt crunch could hurt banks and the wider economy.

Growth in borrowing by heavily ­indebted companies and those with "junk" credit status is rising at levels seen in sub-prime mortgages before the financial crisis and now stands at more than US$1 trillion ($1.5t) globally.

The Bank's Financial Policy Committee (FPC) is "concerned" the surging debts could build new vulnerabilities in the financial system, reports the Daily Telegraph.

The debts, known as leveraged or covenant-lite loans, are typically packaged up and sold on.

Sir Jon Cunliffe, deputy governor at the Bank, said this shows similarities with the credit crunch.

"The things that are similar [to the sub-prime crisis] are the size and the fast rate of growth," he told the Treasury select committee, adding that this type of lending has hit £30 billion ($59.6b) this year.

"Secondly, we're seeing a weakening in underwriting standards. The other similarity is the packaging and distribution [of the bonds]."

He was speaking after ratings agency Moody's warned that companies are piling on debt and making themselves vulnerable to the next downturn.

"A tight covenant structure is good for lenders. Because it inhibits the company from taking certain actions to the detriment of lenders. A loose covenant structure is generally credit negative," said Peter Firth of Moody's.

Loose covenants can worsen the ­position of a company from a lender's perspective, either by allowing weaker corporate performance or by making it easier to layer debt upon existing creditors. This leaves the door open to firms becoming over indebted.

"The higher proportion of vulnerable leveraged companies is sowing the seeds for a spike in the default rate when the next credit downturn strikes," Moody's said.

"Even in the broadly benign credit environment of the last two years we have seen the highest volume of defaulters since 2009, driven by the higher absolute volume of weaker companies now rated," it added.

Sir Jon said the Bank of England will include these bonds in future stress tests, which examine the impact of a ­recession on banks' financial stability.

Banks do not give out these loans but they can hold them for a time, creating a risk if the borrowers collapse at that moment. He did add that it is not yet at crisis levels and has "some big differences" to the pre-crisis debt storm.

"We [the FPC] were not trying to say, this is sub-prime. But what we are trying to say is, this is growing fast, it is now 20 per cent of corporate borrowing in the UK with highly indebted ­companies coming through some of these routes."