“You’re going to have massive defaults as the economy turns down, and a massive amount of dumping of the worst debt as certain investment vehicles like mutual funds are getting out of it,” said Dennis Kelleher, who heads the financial regulation advocacy group Better Markets. “You put those two things together, and there is an enormous threat coming to all financial institutions, but particularly the biggest banks.”
According to financial analytics firm Trepp, banks have diversified the sectors that they’re invested in, but have particular exposure to companies in real estate; about 10 percent of outstanding corporate loans at a surveyed group of large and medium-size banks were in that sector.
Corporate debt could also grow. Companies like Boeing are reportedly drawing on existing lines of credit, while United Airlines is one of the coronavirus-hit businesses that has taken out a new secured loan to help weather decreased revenue.
Lee Shaiman, executive director of the Loan Syndications and Trading Association, said bundles of loans to highly indebted companies, known as collateralized loan obligations, aren’t at much risk from the industries that are being hardest hit, like energy and travel.
“You don’t want to be Pollyanna-ish,” he said. “We’re in for a rough couple of weeks at least, but it’s very clear why we’re here, as opposed to the financial crisis where there were a lot of reasons and a lot of excesses.”
Those CLOs are more transparent and more conservatively structured than the mortgage-backed securities that helped lead to the 2008 blowup, he said. Meanwhile, a lot of payments won’t even be due for years.
Still, financial firms are connected to each other in ways that aren’t always clear, which will lead to an intense focus on how large indebted companies are faring.
“This is a tinder box that the current regulators have told us is not of concern” for the broader financial system, said Sarah Bloom Raskin, former deputy Treasury secretary and onetime Fed board member. “We will see the extent to which their confidence is warranted.”
Raskin also said banks need to be preparing to defer payments from small businesses and people who might be late on mortgage or credit card payments, something their regulators last week encouraged them to do. Some banks have already announced rate reductions on loans for vulnerable borrowers.
“These are contributors to how long and deep this downturn is going to be,” she said.