Optimistic accounting and weakening deal terms have money managers and official institutions sounding warning bells on leveraged finance.
In recent months, a number of institutions and central banks have highlighted concerns over the leveraged loan market, which the International Monetary Fund tallied as a $1.3 trillion global market.
On its website last month, the IMF outlined its worries in a blog post.
"At this late stage of the credit cycle, with signs reminiscent of past episodes of excess, it's vital to ask: How vulnerable is the leveraged loan market to a sudden shift in investor risk appetite?" the IMF asked.
Leveraged loan issuance has reached about $745 billion so far this year, according to the IMF, although figures do show a slowdown in October. That compares with last year's record $788 billion in issuance, which surpassed a pre-crisis high of $762 billion in 2007.
"It is not only the sheer volume of debt that is causing concern. Underwriting standards and credit quality have deteriorated," the IMF wrote. It noted that new deals include fewer investor protections, with a proliferation of so-called covenant-light loans, and that more than half of this year's total issuance "involves money borrowed to fund mergers and acquisitions and leveraged buyouts, pay dividends, and buy back shares from investor(s) — in other words, for financial risk-taking rather than plain-vanilla productive investment," the IMF wrote.
Institutional investors' involvement in the leveraged loan market also worries the IMF, which said these institutions now hold about $1.1 trillion of leveraged loans in the U.S., a figure that has almost doubled since before the global financial crisis.
Institutional bank loan assets under management totaled $672.4 billion as of Sept. 30, according to data from eVestment LLC, down 5.2% vs. Sept. 30, 2017, but up 14.4% from Sept. 30, 2016.