60% of leveraged loans are now covenant-light and most deals have substantial “add backs” of EBITDA.20 These are developments analogous to the “No Doc / No Income” heyday of US subprime. To add to the sense of déjà vu, growth in leveraged loans has been increasingly driven by securitisation. Chart 8: New leveraged loans to US companies have become riskier  Average  Median  Riskiest 25%  Total debt to EBITDA 7  6  5  4 Post-crisis avg  2017  2018  Source: LCD, an offering of S&P Global Market Intelligence. Notes: The chart includes leveraged loans issued to US corporate borrowers. Total debt to EBITDA is measured postissuance and is not adjusted for EBITDA add-backs, which have increased in size and prevalence in recent years. There are some important differences between leveraged lending today and subprime a decade ago. Nonbanks are playing much smaller roles in origination, and ‘skin-in-the-game’ rules had, until recently, aligned  19 In the US, gross corporate debt as a share of annual earnings was 266% in Q3 2018, compared to 262% at the end of 2007. On the same measure UK corporate debt to earnings was 312% in Q3 2018 compared to 336% at the end of the 2007, but excluding the leverage of UK companies in the CRE sector it is above pre-crisis levels (301% in Q3 2018 vs 278% at end-2007). See the Bank of England’s November 2018 Financial Stability Report for more details.
BIS central bankers’ speeches  1  Chart 2  Four years after the financial crisis engulfed the world, a European version has now emerged. Both market participants and the authorities failed in their assessments after the introduction of a single currency. Prior to the introduction of the Economic and Monetary Union, there were wide differences between interest rates facing different European countries, which primarily reflected different inflation expectations across countries. But through the 1990s, long-term interest rates drifted down to German levels. Over the next 10 years, sovereign interest rates were fairly similar – and very low – for all euro area countries despite wide differences in debt levels, budget deficits and growth rates. Market participants did not take into account differences in sovereign creditworthiness. Sovereign debt was treated as virtually risk-free, both in the markets and by the authorities. The period contrasts with the recent two to three years during which interest rates on sovereign debt have widened sharply. For many countries, interest rates have reached very high levels. In retrospect, we see that market participants failed in their risk assessment through the ten years following the introduction of the euro. Economic policy also failed. EU rules relating to budget deficits and public debt were disregarded early on when Germany and France exceeded the limits they had so eagerly advocated when the European Monetary Union was established. Other countries followed their example. Low interest rates made it easy to finance deficits by issuing new debt.