JPMorgan Sees Parallel to Subprime Bust at Regional Banks

NEW YORK (TheStreet) -- A boom in leveraged loans issued by large and regional banks, or low-rated debt used to finance private-equity buyouts, is drawing alarming comparisons to the subprime mortgage boom in 2006 and 2007. According to one analyst, banks such as Regions Financial (RF), Fifth Third Bancorp (FITB), and Citigroup (C) are most at risk of getting caught up in the market froth.

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The warning call, made by JPMorgan analyst Vivek Januja, cited a surge in the issuance of leveraged loans in recent years and the prospect that deterioration in underwriting standards materializes as a risk for banks and investors in coming years. The quality of 2013 issues and those made in the first quarter of 2014 is solid. However, Januja said he foresees the prospect that investors may soon overreach.

"The boom in these loans has been fed by continued surge of inflows into leveraged loan funds. The genesis of this voracious interest is the search for yield, similar to the strong growth in subprime mortgages in 2006-2007," Januja said.

"Credit quality remains good currently, but an interesting shift bears watching -- the number of loan downgrades is up sharply and exceeded upgrades in 2013 for the first time since 2009 and downgrades in 1Q14 are already at about double the pace of 2013," he added.

A rise in ratings downgrades to leveraged loan securities could present a risk for banks that have grown their share in the market in the past 12 to 18 months, Januja said. For some regional banks, leveraged loan volumes have risen three-to-fourfold over the past few years, while the nation's largest banks have also rapidly increased their issuance amid booming LBO markets.

The analyst sees those risks as most acute at Fifth Third, which has grown its leverage loan syndication volume to $5.3 billion in 2013 from $1.2 billion in 2011, and at Regions Financial, which grew volumes to $4.5 billion from $1.9 billion over that same time period. In the first quarter of 2014, Fifth Third grew its leveraged loan syndication volume 42%, according to Januja's calculations, while Regions grew volumes 24% year over year.

Among large banks, Citigroup has stepped up its leveraged loan issuance the fastest, with volumes rising 74% from 2011 to 2013, and LBO underwriting fees the fastest among large banks. Bank of America (BAC) and Wells Fargo (WFC) have also seen issuance rise 30% year over year, with leveraged loan fees accounting for 33% to 38% of their underwriting fees, according to Junuja's calculations.

It is worth noting that JPMorgan analyst Januja's figures indicate his firm has been the biggest issuer in 2014 and in recent years. In 2013, JPMorgan participated in two of the biggest leveraged loan deals, the buyouts of Dell and Heinz.

Januja highlighted BBT (BBT) as the lender that has been "by far the most cautious, with a de minimis amount of leveraged loans." BBT has not participated in a single leveraged loan deal in 2014, according to JPMorgan's figures.

Overall, leveraged loan volumes grew to $1.1 trillion in the U.S. in 2013, surpassing the trillion-dollar mark for the first time since the crisis. In 2014, leveraged loan issuance represented 50% of total syndicated loans.

The Fed Steps In

Last March, the Federal Reserve, Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. provided guidance on leveraged loan underwriting standards. Those regulators indicated banks should avoid financing deals with debt ratios of beyond six times earnings before interest, taxes, depreciation and amortization, and have more concrete rules about underwriting standards.

Januja, the JPMorgan analyst, said he believes higher scrutiny of leveraged loan issuance could lower underwriting fees for large banks, shift deals to non-bank lenders, make the low-rated tranches hard to sell and become a key point of focus during the Fed's annual stress testing review.

It is worth noting that Citigroup, one of the fastest growing leveraged loan issuers, failed this year's stress tests.

-- Written by Antoine Gara in New York

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