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.
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.