A recent study from the University of Bath has raised alarms about the growing systemic risks in the US leveraged loan market, suggesting these could pave the way for another financial crisis. The study, published on June 25, 2025, identifies several concerning trends, including the underpricing of loans, the increasing role of less-regulated non-bank lenders, and the decline in loan standards.
Leveraged loans, which are extended to companies with high levels of debt or weaker credit histories, are becoming increasingly underpriced, especially by non-bank lenders. These lenders, operating with less regulatory oversight than traditional banks, are contributing to a market where the risk premium has significantly declined for the riskiest borrowers since 2014. This trend is compounded by the rise of Collateralized Loan Obligations (CLOs), which now account for approximately 70% of the US leveraged loan market, creating complex structures that may obscure the true risk to investors.
Furthermore, the prevalence of 'covenant-lite' loans, which offer fewer protections for lenders, is exacerbating the risk. These loans allow borrowers more flexibility even as their financial health deteriorates, making it harder for lenders to mitigate losses. The default rates on US leveraged loans have already reached a four-year high of 7.2% in December 2024, with many borrowers resorting to 'distressed exchanges' to avoid bankruptcy.
Regulators are increasingly concerned about the rapid growth and interconnections within the private credit market, which could pose a systemic threat to financial stability. The study underscores the need for a comprehensive federal framework to address the risks posed by non-bank lenders and the broader leveraged loan market.
