FSOC: Financial Stability Risks ‘Elevated’ as Pandemic Continues

Rising corporate debt, vulnerabilities in short-term wholesale funding markets and commercial real estate were among several risks flagged by the Financial Stability Oversight Council in its annual report released today. The reported noted that “risks to U.S. financial stability remain elevated compared to last year,” and that “the global outlook for economic recovery is uncertain, depending on the severity and the duration of the ongoing pandemic.”

FSOC noted that corporate debt relative to U.S. GDP was already at historic highs before the COVID-19 pandemic began, and that since March, nearly $2 trillion in nonfinancial corporate debt has been downgraded, while default rates on leveraged loans and corporate bonds have increased. Meanwhile, FSOC observed “potentially significant structural vulnerabilities” in short-term funding markets, and called on regulators to review—among other things—the vulnerability of large-scale redemptions in prime and tax-exempt money market funds, and take “appropriate measures” to address them.

With regard to real estate, FSOC cautioned that CRE remains vulnerable to defaults and declines in valuations—which could leave creditor banks vulnerable to losses and write-downs and ultimately lead to credit tightening. In a statement responding to the report today—and acknowledging the banking industry’s strong response to the pandemic—FDIC Chairman Jelena McWilliams addressed the CRE sector in particular. She emphasized that “the composition of the industry’s CRE holdings is different today than in the last crisis.”

In particular, she noted that aggregate concentrations for CRE loans are lower than they were in the lead-up to the 2008 financial crisis. “We continue to urge banks to work with their borrowers and confirm that they have significant flexibility to do so,” McWilliams said.