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Banks, Shadow Lenders Risk ‘Race To The Bottom’ In Corporate Bond Market

Analysts are warning that rising competition among large lenders and shadow banks to issue junk bonds may cause a “race to the bottom” and uncover greater risks.

Reports in Bloomberg on Thursday (July 12) said the junk bonds and leveraged loans market is worth $2.3 trillion, and competition is rising as regulators slowly ease restrictions on banks’ corporate lending practices.

The Federal Reserve issued guidance in 2013 to curb leverage in an effort to prevent a financial crisis repeat, the publication said, but regulators failed to predict the emergence of shadow lenders and non-bank players. Bloomberg said less-regulated regulators saw sharp increases in their share of new U.S. leveraged loans underwritten between 2013 and 2017 as a result of the regulations.

The publication’s own analysis found that the top 10 most regulated banks account for about 54 percent of U.S. leveraged loans in 2018, compared with 70 percent in 2013.

Frank Ossino, senior portfolio manager at Newfleet Asset Management, told the publication that the result of this competition could create a “race to the bottom,” as lenders clamor to issue debt used in corporate takeovers.

“The real test will be the market reaction and ultimate recovery if loans made by these entities begin to default,” he said.

“Business is going to go wherever it can to get business done, and that’s wherever the regulators are not,” said Quill Intelligence Founder Danielle DiMartino Booth, former Federal Reserve Bank of Dallas advisor, in another interview with Bloomberg.

Traditional lenders remain dominant in this space, and continue to increase their share of junk-rated corporate debt amid deleveraging. Lenders collected $6.6 billion in fees linked to these loans in the first half of 2018, reports said, with analysts at Freeman Consulting Services predicting that those fees will reach an all-time high by the end of this year.

Reports last year said that retailers have experienced a particularly high increase of junk ratings since the beginning of 2017, with as much as 18 percent of retailers landing a CCC rating by Standard and Poor’s. More than a fifth of retail and restaurants assessed by S&P were deemed high risk.

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