Study Warns of Growing Systemic Risks in US Leveraged Loan Market

The US leveraged loan market is facing growing systemic risks, according to a recent study from the University of Bath, which warns of the potential for another financial crisis. The study, published on June 25, 2025, identifies several concerning trends, including the underpricing of highly leveraged loans, the increasing role of less-regulated non-bank lenders, and a decline in loan standards. These factors collectively contribute to a fragile market environment where default rates have surged to a four-year high of 7.2% in December 2024.

Leveraged loans, which are extended to companies with high levels of debt or weaker credit histories, are inherently riskier. The study notes a significant weakening in the pricing of leverage risk since 2014, with the risk premium declining most for the riskiest borrowers. This trend reflects structural weaknesses in the leveraged lending landscape, exacerbated by the rise of non-bank lenders. These 'shadow lenders' operate with less regulatory oversight than traditional banks, raising concerns about unchecked risk-taking and a lack of transparency.

Another critical factor is the surge in Collateralized Loan Obligation (CLO) issuance, which now accounts for approximately 70% of the US leveraged loan market. CLOs package leveraged loans into securities sold to investors, transferring risk away from original lenders but creating complex, opaque structures. Additionally, the widespread adoption of 'covenant-lite' loans, which offer fewer protective clauses for lenders, further exacerbates market risks by making it harder to mitigate losses in times of distress.

Regulators have begun to express heightened concern over the rapid growth and increasing interconnections within the private credit market, which largely comprises non-bank lenders and their leveraged loan activities. The sheer size of this market means that any significant disruption could pose a systemic threat to financial stability. While past assessments suggested leveraged lending did not significantly threaten stability during the COVID-19 pandemic, the current environment presents renewed challenges due to increased underpricing and diminished oversight.

Parallel to the corporate leveraged loan market, the personal loan sector for individuals with bad credit is also experiencing growth, driven by demand for debt consolidation. However, these loans often come with high costs, including triple-digit APRs for borrowers with very low credit scores, raising concerns about potential debt traps.