Many large banks originate leveraged loans with an intent to distribute, often to CLOs. While the direct exposures of the banking system in the form of loan portfolios and warehousing exposures can be monitored, there are also indirect exposures, including through bank investments in CLOs and credit lines, which bear vigilance. By contrast, nonbank exposures are harder for us to track.
To date, the default rate on leveraged loans has been at the low end of its historical range, and corporate credit conditions have been favorable, with low interest expenses and low expected default rates. However, if spreads rise sharply or economic conditions deteriorate significantly, we could see downgrades, refinancing challenges, rising delinquencies and defaults, and losses to investors.