The US government’s financial stability watchdog has warned that a potential wave of corporate debt defaults looms as markets signal the US is heading towards a downturn in the credit cycle.
In an annual report to Congress, The Office of Financial Research (OFR) said that the risk of borrowers failing to repay their debts was “high and rising” among US businesses outside the financial sector.
The warning from the OFR – which identified corporate credit as one of the biggest three financial stability risks in the year ahead – adds to similar alerts from credit rating agencies, Barney Jopson reports in Washington and Eric Platt in New York.
The report said:
Debt among nonfinancial companies has been growing for years and is at a historic high relative to US gross domestic product. In addition, the ratio of debt to earnings for nonfinancial US corporations will rise further if earnings continue to decline.
The buildup of debt is starkest among companies already vulnerable because of existing debt levels and weakening capacity for repaying their debts.
Elevated debt and sinking earnings, the OFR noted, are hallmarks of the late stage of the credit cycle.
In a chart the agency highlighted the US’s precarious position compared with the rest of the world, with Europe and Japan in a credit recovery phase while emerging markets are already well into a downturn.
The rock bottom price of oil and other commodities has put borrowers in the energy, metals and mining sectors under intense stress. Regional banks with exposure to energy companies had pre-emptively increased loan loss reserves, the OFR noted, “but the ultimate magnitude of losses in these industries and regions is uncertain”.
Credit downgrades in 2015 reached the highest level since the end of the financial crisis in 2009, data from Standard & Poor’s shows.
The agency cut its ratings on 461 US groups last year, up 67 per cent from a year earlier, with more than $1.5tn of debt downgraded in the last three months of the year. In contrast, companies with debt worth $100bn were upgraded in the final quarter of 2015.
The other top two risks highlighted by the OFR were the long-term impact of risk-taking spurred by persistently low interest rates and the uneven resilience of the financial system.
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