The U.S. economy is on solid footing except for one potential trouble spot, according to Bank of America Corp. Chief Executive Brian Moynihan: leveraged loans — a business the bank has dominated for a decade.
Problems aren’t yet emerging as the economic expansion continues and companies churn out profits, Moynihan said Tuesday at the Economic Club of New York. His own bank has repeatedly said it focuses on “responsible growth” and sticks to lending standards it has had for years. But leveraged finance threatens to become an issue in the broader market, he said.
“It’ll be ugly for those companies if the economy slows down and they can’t carry the debt and then restructure it, and then the usual carnage goes on,” Moynihan said. He also pointed to weakening terms in the wider market for riskier corporate lending.
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Bank of America is sitting atop a ranking of leveraged-loan book runners for a 10th year, according to data compiled by Bloomberg. The firm has limited exposure to collateralized loan obligations, Chief Financial Officer Paul Donofrio said in January.
“We don’t see anything yet because the economy’s good, the companies are making money,” Moynihan said Tuesday. “The issue that’s there is in the leveraged finance.”
Weaker terms
Moody’s Investors Service said covenant quality for 2018’s last quarter was near a record low, and the rating company sees no signs of improvement this year. Federal Reserve Chairman Jerome H. Powell said last month that the market looks a lot like the mortgage industry in the run-up to the subprime crisis. But U.S. regulators are watching closely this time around and the financial system is better shielded, Powell said.
The trend toward weaker terms is something “we should worry about,” Moynihan said Tuesday. “We aren’t lowering standards, because we tried that once and it didn’t work so well,” he said, to laughter in the audience.
The leveraged loan market is relatively small, meaning any shakeout is less likely to affect broader markets, according to Moynihan. The “real debate” belongs with the leveraged finance deals that are done outside of banks, Moynihan said — echoing views of financial watchdogs who have expressed concerns that risk has shifted outside their purview.
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Market share
Bank of America was book runner on some $317 billion of leveraged loans this year, accounting for 10.8% of the market share, according to Bloomberg data, which capture all leveraged term loans and revolver facilities that are either new or have been amended.
That compares with $688 billion for last year, when Bank of America led the loan portion of Blackstone Group’s buyout of Thomson Reuters Corp.’s Refinitiv unit. Leveraged loan volumes this year have fallen as investors flee from riskier assets and pull money from loan funds as a pause in interest-rate hikes dims those funds’ allure.
The bank had shied away from riskier leveraged finance amid steeper competition from nonbanks, Donofrio said in October. For M&A bankers, it sought to loosen reins a little after getting “a little too careful,” Moynihan said in December.
On the economy, Moynihan said economic activity and confidence remain strong among U.S. consumers and businesses. Even a recent slowdown in capital expenditures by businesses is consistent with a healthy economy, he said, adding that strong underlying economic data are more important indicators of growth than the possibility of a recession signaled by an inverted yield curve.
On Tuesday, Fed chief Powell suggested he was open to cutting interest rates, given fallout from disputes between the United States and its largest trading partners. St. Louis Fed President James Bullard said Monday that interest rates may need to decline to prop up inflation and counter economic risks from the trade war.
Moynihan doesn’t expect the Fed to lower interest rates this year, saying the ongoing trade battles aren’t enough to warrant recession concerns.
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“Right now you don’t see the impacts,” he said. “I think the economy’s stronger than people think.”
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