OFR_2016_Financial-Stability-Report

Figure 11. Estimated Duration of U.S. Bond Market
Investments (years)
The average duration of U.S. bond investments remains
at long-term high levels
6
5
4
Barclays U.S. Aggregate Index duration
3
1990 1995 2000 2005 2010 2015
Note: Data as of Oct. 31, 2016.
Source: Bloomberg Finance L.P.
Figure 12. Covenant-Lite Share of Leveraged Loans
(percent)
Covenant-lite loans now account for more than two-thirds
of total leveraged loans outstanding
70
60
50
40
30
20
10
0
2006 2008 2010 2012 2014 2016
Source: Standard and Poor’s Leveraged Commentary & Data
time, financial firms may have limited ability at current
levels to reprice their liabilities, even as their asset yields
continue to fall. Together, these factors can erode firms’
ability to generate capital. We are concerned about the
market risks facing U.S. banks and insurers, as discussed
in depth in Chapter 2.
U.S. Nonfinancial Corporate Credit
Risks Remain High
Measures of credit risk — the risk of borrowers or counterparties
not meeting financial obligations — are elevated
in U.S. nonfinancial corporate credit, as debt continues
to grow rapidly. The ratio of such debt to GDP is now
above its 2007 level. Measures of firms’ leverage are also
high, as described in Chapter 2. Covenant-lite (lacking
strict legal covenants) loans have grown rapidly since
2008. Covenant-lite loans now account for two-thirds
of corporate leveraged loans outstanding, compared
with less than a third during previous cycles (see Figure
12). U.S. firms have increased leverage in recent years by
issuing debt and buying back their stock. Leverage boosts
prices and returns on equity, but also increases credit
risks. Those risks are largely borne by U.S. banks, life
insurers, mutual funds, and pension funds (see Chapter
2 and Monitoring Shadow Banking Risks).
Excessive borrowing by households and financial
firms played a key part in the financial crisis. Aggregate
debt burdens in both areas have declined sharply since
then. Leverage ratios have improved for households and
some key financial industries. Leverage among banks is
declining as banks’ capital ratios improve. The ratio of
tangible equity to tangible assets for U.S. global systemically
important banks (G-SIBs) rose from 5.9 percent
in 2010 to 7.2 percent in 2015, although some G-SIBs
reported declines in their capital ratios over the same
period.
Leverage remains high for some nonbank financial
institutions. The 10 largest hedge funds by gross assets
have average leverage of 15-to-1, based on the ratio of
gross to net assets (see Figure 15). Much of this leverage
is obtained through short-term borrowing. This ratio
may understate funds’ leverage because it does not
12 2016 | OFR Financial Stability Report