Fed's Kaplan Warns About Corporate Debt Should Downturn Come

(Bloomberg) -- Federal Reserve Bank of Dallas President Robert Kaplan is sounding a warning bell on U.S. corporate debt, arguing it could pose risks to the economy should growth sour.

“U.S. nonfinancial corporate debt as a percentage of GDP is now higher than the prior peak reached at the end of 2008,” Kaplan points out in an essay published Tuesday. In the event of an economic downturn, issues surrounding those loans could “contribute to a deterioration in financial conditions which could, in turn, amplify the severity of a growth slowdown in the U.S. economy.”

Kaplan isn't the first to call out rising debt among businesses. Fed Chairman Jerome Powell told lawmakers during Feb. 27 congressional testimony that credit risks in the leveraged loan market -- in which borrowers are already highly indebted -- could pose macroeconomic, but not systemic, risk in the event of an economic downturn.

Kaplan dwelt on the leveraged loan market in his essay. He noted that there's been a rise in loans to highly-indebted companies from commercial banks that are then sold to non-bank investors -- often via collateralized loan obligations, which bundle them together to spread out risk. So-called syndicated leveraged loans climbed to $1.2 trillion by the end of 2018 from just $0.6 trillion in 2008.

“Because CLOs are today the largest buyer of these syndicated leveraged loans, disruptions to CLO creation could increase the likelihood that leveraged loans remain on bank balance sheets, which could, in turn, limit the ability of affected banks to extend credit during periods of stress,” Kaplan writes.

The Dallas Fed chief is also “carefully tracking” the growth in less-than-investment grade debt, he said.

“In the event of a downturn, highly indebted companies may be more vulnerable to seeing their credit quality deteriorate, which could negatively impact their capital spending and hiring plans,” he writes.

And it's not just corporate debt that caught Kaplan's eye.

Growing U.S. government debt “means, at a minimum, there is less capacity for infrastructure spending and other investments which might help build the productive capability of the U.S. economy,” he writes. “An elevated level of corporate debt, along with the high level of U.S. government debt, is likely to mean that the U.S. economy is much more interest rate sensitive than it has been historically.”

To contact the reporter on this story: Jeanna Smialek in New York at jsmialek1@bloomberg.net

To contact the editors responsible for this story: Brendan Murray at brmurray@bloomberg.net, Alister Bull

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