Business debt is historically high relative to U.S. gross domestic product, with debt increasing most rapidly among the riskiest firms amid weak credit standards, the Federal Reserve said today in its financial stability report. However, “the core of the financial sector appears resilient, with leverage low and funding risk limited relative to the levels of recent decades,” it said. The report—which is published twice a year—examines the resilience of the financial system and highlights potential vulnerabilities.
Growth of business debt remained above the growth rate of economic output in the first half of 2019, and the Fed noted that the net issuance of riskier forms of business debt, including high-yield bonds and institutional leveraged loans—which grew 14.6% year-on-year—remained robust in 2019. The Fed noted, however, that “credit performance of leveraged loans has been solid so far, with low default rates.” In contrast, household borrowing remained modest relative to income, with debt owed by subprime consumers remaining flat.
Meanwhile, the nation’s largest banks remain well capitalized, and the Fed noted that “these banks are well-positioned to continue lending to households and businesses in the event of a severe global recession.” However, the Fed noted that the falling interest rate environment has negatively affected the outlook for bank profitability. The Fed also pointed to several near-term risks that could pose potential risks to the financial system. While the current U.S. expansion is expected to continue, the report cautioned that a sudden downturn could lead to financial stresses and defaults at some firms, given the high amount of leverage in the nonfinancial sector.