Small businesses fuel subprime loans boom - report
A report from New York Times The Dealbook said subprime loans were making a comeback among small businesses. Subprime loans are particularly risky because they only have few of the standard protections that are normally seen in ordinary loans.
One of the companies who obtained a subprime loan last month from Deutsche Bank and GE Capital was Learfield Communications, a company based in Jefferson City, Missouri that earned under USD 40 million last year. The report said Learfield Communications was granted a USD 330 million loan package from the two Wall Street banks.
Smaller companies like Learfield are the new targets of investors. According to the report, private equity firms, Wall Street, hedge funds and others were now turning to riskier but more lucrative investments because other forms of debt offered low returns. Learfield reportedly obtained what is known as a leveraged loan because it was able to borrow money that was eight times higher than its earnings. According to the report, leveraged loans were highly popular before the financial crisis 2008, but disappeared for a while after the collapse. Starting in 2010, these types of loans have started to return. For this year, the volume of leveraged loans made until November 14 has reached USD 548.4 billion. This was even more than the USD 535 .3 billion made in 2007 before the financial crisis.
The report also said Learfield's loan is known as a covenant-lite loan. Covenant-lite loans, as explained in the report, are not equipped with mechanisms that serve to warn investors of possible financial issues of the company that may affect loan repayment.
This reportedly made regulators worry. In March, the USFederal Reserve, Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation issued a note about the rise of subprime loans. They said prudent lending practices have declined and encouraged banks to follow stricter standards in issuing loans.