OFR_2016_Financial-Stability-Report

Figure 36. U.S. Corporate Bond Default
Rates (percent); Commercial Real Estate Loan
Delinquencies (percent); and Equity and Commercial
Real Estate Sell-Offs (shaded periods)
Corporate default waves coincided with equity and
commercial real estate sell-offs
12
10
future returns, discounted by real interest rates. Small
changes in low interest rates create large changes in net
present values. Thus, when interest rates are low, their
shifts are a more important common factor driving
prices across asset classes.
Sharp declines in equity and commercial real estate
prices during a debt default wave could compound
investor losses and further shake confidence. The risk to
financial stability could rise in turn.
8
6
4
2
0
1980 1985 1990 1995 2000 2005 2010 2015
U.S. corporate bond default rate
U.S. commercial real estate loan delinquency rate
U.S. equity sell-off
U.S. commercial real estate sell-off
Note: Data as of June 2016. Commercial real estate deliquency
data begin in 1990. U.S. equity sell-offs are defined as declines of
20 percent or more in the S&P 500. U.S. commercial real estate
sell-offs are defined as declines of 20 percent or more in the
inflation-adjusted Federal Reserve Board commercial property
price index.
Sources: Haver Analytics, Moody’s Default and Recovery Database,
Standard & Poor’s
Default Risks Could Threaten Financial
Stability
A severe increase in defaults in nonfinancial corporate
debt could cause financial instability. It has happened
before. During the U.S. savings and loan crisis of the
1980s and 1990s, the exposed institutions could not
manage their losses on commercial lending and commercial
real estate. Widespread failures of these institutions
disrupted credit to the real economy and cost U.S.
taxpayers billions.
The impact on financial stability would depend on
the ability of exposed creditors to manage credit losses,
market losses, spillovers to the equity and commercial
property markets, and any erosion of confidence from
their own investors and creditors. Today, the major creditors
of U.S. nonfinancial corporations are U.S. banks,
mutual funds, life insurers, and pension funds (see
Figure 37). Evaluating whether these other entities are
resilient enough to manage the fallout from a severely
adverse scenario is critical. Their distress could impair
the flow of credit to the economy. It could also amplify
and propagate stress through fire-sale dynamics in the tradable segments of
these markets.
Higher capital levels and stronger liquidity have made the U.S. banking
system far more resilient than before the crisis. Still, some large U.S. banks
have combined concentrations of commercial real estate and commercial
and industrial (C&I) loans of more than 200 percent of capital (see Figure
38). A severe increase in defaults affecting both could significantly erode
some large banks’ capital adequacy.
The risks that exposed nonbank firms face vary and are different from
those of banks, given different business models and liability structures.
For example, mutual funds face a well-known liquidity mismatch in their
34 2016 | OFR Financial Stability Report