2. Borrowing by businesses and households

The high level of business-sector debt is likely to amplify the adverse effects of the COVID-19 outbreak

Vulnerabilities arising from business debt were elevated at the end of 2019, while vulnerabilities arising from household debt were at more modest levels. Business debt levels were high relative to either business assets or GDP, with the riskiest firms accounting for most of the increase in debt in recent years. By contrast, household borrowing has advanced more slowly than overall economic activity in recent years and remained heavily concentrated among borrowers with high credit scores.

Against this backdrop, the COVID-19 outbreak poses severe risks to businesses of all sizes and millions of households. Economic activity is contracting sharply, and the associated reduction in earnings and increase in credit needed to bridge the downturn will expand the debt burden and default risk of a highly leveraged business sector. While household debt vulnerabilities were generally modest before the pandemic, the severity of the shock and the associated sudden increase in unemployment and sharp decline in incomes may lead to a significant rise in delinquencies and defaults on household debt.

Table 2 shows the volume and recent historical growth rates of forms of debt owed by nonfinancial businesses and households as of the end of 2019. Total outstanding private credit was split almost equally between businesses and households, with each owing close to $16 trillion.

Table 2. Outstanding Amounts of Nonfinancial Business and Household Credit
Item Outstanding
(billions of dollars)
Growth, 2018:Q4–2019:Q4
(percent)
Average annual growth, 1997–2019:Q4
(percent)
Total private nonfinancial credit 32,207 4.2 5.5
Total nonfinancial business credit 16,058 4.8 5.7
Corporate business credit 10,117 4.7 5
Bonds and commercial paper 6,558 4.1 5.6
Bank lending 1,425 3.5 2.8
Leveraged loans* 1,134 5 15.1
Noncorporate business credit 5,941 4.9 7.2
Commercial real estate 2,508 6.2 6.2
Total household credit 16,149 3.5 5.4
Mortgages 10,610 3 5.6
Consumer credit 4,191 4.5 5.3
Student loans 1,643 4.7 9.3
Auto loans 1,196 3.8 5
Credit cards 1,093 3.8 3.5
Nominal GDP 21,727 3.7 4.2

Note: The data extend through 2019:Q4. Growth rates are measured from Q4 of the year immediately preceding the period through Q4 of the final year of the period. The table reports the main components of corporate business credit, total household credit, and consumer credit. Other, smaller components are not reported. The commercial real estate (CRE) row shows CRE debt owed by both corporate and noncorporate businesses. The total household-sector credit includes debt owed by other entities, such as nonprofit organizations. GDP is gross domestic product.

* Leveraged loans included in this table are an estimate of the leveraged loans that are made to nonfinancial businesses only and do not include the small amount of leveraged loans outstanding for financial businesses. The amount outstanding shows institutional leveraged loans and generally excludes loan commitments held by banks. For example, lines of credit are generally excluded from this measure. The average annual growth rate shown for leveraged loans is computed from 2000 to 2019:Q4, as this market was fairly small before 2000.

Source: For leveraged loans, S&P Global, Leveraged Commentary & Data; for GDP, Bureau of Economic Analysis, national income and product accounts; for all other items, Federal Reserve Board, Statistical Release Z.1, "Financial Accounts of the United States."

In the years before the pandemic shock, total private credit advanced roughly in line with economic activity...

Over the past several years, the combined total debt owed by businesses and households expanded at a pace similar to that of nominal GDP. As a result, the nonfinancial-sector credit-to-GDP ratio was broadly stable through the end of 2019, similar to its level in mid-2005, the period preceding the episode of rapid credit growth from 2006 to 2007 (figure 2-1). Going forward, the credit-to-GDP ratio will likely rise dramatically in 2020, as GDP is expected to fall precipitously.

2-1. Private Nonfinancial-Sector Credit-to-GDP Ratio
Figure 2-1. Private Nonfinancial-Sector Credit-to-GDP Ratio
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Note: The shaded bars with top caps indicate periods of business recession as defined by the National Bureau of Economic Research: January 1980–July 1980, July 1981–November 1982, July 1990–March 1991, March 2001–November 2001, and December 2007–June 2009. GDP is gross domestic product.

Source: Federal Reserve Board staff calculations based on Bureau of Economic Analysis, national income and product accounts, and Federal Reserve Board, Statistical Release Z.1, "Financial Accounts of the United States."

Figure 2-2 shows the credit-to-GDP ratio separately for the nonfinancial business and household sectors (the next section discusses leverage of financial firms). The business debt-to-GDP ratio has risen significantly over the past several years, surpassing its historical high. In contrast, the household debt-to-GDP ratio has fallen steadily over the past decade.

2-2. Nonfinancial Business- and Household-Sector Credit-to-GDP Ratios
Figure 2-2. Nonfinancial Business- and Household-Sector Credit-to-GDP
Ratios
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Note: The shaded bars with top caps indicate periods of business recession as defined by the National Bureau of Economic Research: January 1980–July 1980, July 1981–November 1982, July 1990–March 1991, March 2001–November 2001, and December 2007–June 2009. GDP is gross domestic product.

Source: Federal Reserve Board staff calculations based on Bureau of Economic Analysis, national income and product accounts, and Federal Reserve Board, Statistical Release Z.1, "Financial Accounts of the United States."

. . . but business leverage was near its highest level over the past two decades...

An indicator of the leverage of businesses—the ratio of debt to assets for all publicly traded nonfinancial firms—was at its highest level in 20 years at the beginning of 2020 (figure 2-3).11 Moreover, for highly leveraged public firms—defined as firms above the 75th percentile of the leverage distribution—this indicator is close to a record high. The net issuance of riskier forms of business debt—high-yield bonds and institutional leveraged loans—showed some variation but remained high, overall, through 2019 (figure 2-4).

2-3. Gross Balance Sheet Leverage of Public Nonfinancial Businesses
Figure 2-3. Gross Balance Sheet Leverage of Public Nonfinancial
Businesses
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Note: Gross leverage is an asset-weighted average of the ratio of firms' book value of total debt to book value of total assets. The 75th percentile is calculated from a sample of the 2,500 largest firms by assets. The dashed line shows the data after the structural break in the series due to the 2019 compliance deadline for Financial Accounting Standards Board rule Accounting Standards Update 2016–02.

Source: Federal Reserve Board staff calculations based on S&P Global, Compustat.

2-4. Net Issuance of Risky Business Debt
Figure 2-4. Net Issuance of Risky Business Debt
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Note: Institutional leveraged loans generally exclude loan commitments held by banks. Key identifies series in order from top to bottom.

Source: Mergent, Fixed Income Securities Database; S&P Global, Leveraged Commentary & Data.

Historically low interest rates likely lessened investor concerns about default risks arising from higher leverage, as the ratio of earnings to interest expenses (the interest coverage ratio) had remained high for the median firm and near the historical median for riskier firms, defined as those in the bottom 25th percentile of the distribution of this ratio (figure 2.5). As the economic effects of COVID-19 continue to unfold, earnings declines will imply significantly lower interest coverage ratios, which could trigger a sizable increase in firm defaults. Policy interventions may help businesses withstand a period of weak earnings by issuing new debt and extending existing credit, but many of these businesses will emerge with even higher amounts of leverage, suggesting that vulnerabilities stemming from the business sector, including nonpublic companies and small businesses, are likely to remain elevated for some time.

2-5. Interest Coverage Ratios for Public Nonfinancial Businesses
Figure 2-5. Interest Coverage Ratios for Public Nonfinancial
Businesses
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Note: The interest coverage ratio is earning before interest and taxes over interest payments. Firms with leverage less than 5 percent and interest payments less than $500,000 are excluded.

Source: Federal Reserve Board staff calculations based on S&P Global, Compustat.

. . . and debt owed by large corporate businesses has already shown some signs of amplifying the economic effects of COVID-19

Business debt growth picked up during January and most of February. Early indicators point to a sharp slowdown in new debt since the end of February, while businesses have also started drawing on existing credit lines at banks (see the box "Risks Associated with Banks' Corporate Credit Exposures through Credit Lines"). Against this backdrop, approximately $170 billion of investment-grade corporate bonds and $29 billion of speculative-grade corporate bonds issued by nonfinancial corporations are set to mature before the end of 2020, representing 25 percent and 11 percent, respectively, of the average annual nonfinancial corporate issuance of each grade over the past five years. While bond issuance has resumed, particularly for investment-grade bonds, and policy interventions appear to be supporting lending, tight financing conditions could compromise the ability of some businesses to refinance their existing debt and, as a result, intensify the economic effects of the pandemic on these businesses' employment and investment decisions.

At the beginning of 2020, about half of investment-grade debt outstanding was rated in the lowest category of the investment-grade range (triple-B)—near an all-time high. The amount of debt downgraded from investment grade to speculative grade in 2019 was close to the historical average over the past five years. However, almost $125 billion of nonfinancial investment-grade corporate debt has been downgraded to speculative grade since late February, and expected defaults may rise if the economic outlook and corporate earnings are revised downward. Widespread downgrades of bonds to speculative-grade ratings could lead investors to accelerate the sale of downgraded bonds, possibly generating market dislocation and downward price pressures in a segment of the corporate bond market known to exhibit relatively low liquidity.12

Similarly, vulnerabilities stemming from leveraged lending were increasing through mid-February 2020, as demand remained strong while credit standards stayed weak. Issuance came to a halt at the end of February, as investors became more cautious and attentive to volatility in financial markets. Reflecting this change in sentiment, the share of newly issued loans to large corporations with high leverage—defined as those with ratios of debt to earnings before interest, taxes, depreciation, and amortization greater than 6—dropped in the first quarter of 2020 after two years in which the share reached historical highs (figure 2-6). Defaults on leveraged loans ticked up in February and March and are likely to continue to increase, with the specific contour highly dependent on the path of overall economic activity (figure 2-7). Such developments would weaken the balance sheets of lenders, including CLOs that hold leveraged loans, and amplify the economic effects of COVID-19.

2-6. Distribution of Large Institutional Leveraged Loan Volumes, by Debt-to-EBITDA Ratio
Figure 2-6. Distribution of Large Institutional Leveraged Loan
Volumes, by Debt-to-EBITDA Ratio
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Note: Volumes are for large corporations with earnings before interest, taxes, depreciation, and amortization (EBITDA) greater than $50 million and exclude existing tranches of add-ons and amendments as well as restatements with no new money. Key identifies bars in order from top to bottom.

Source: S&P Global, Leveraged Commentary & Data.

2-7. Default Rates of Leveraged Loans
Figure 2-7. Default Rates of Leveraged Loans
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Note: The data begin 2004:Q2. The default rate is calculated as the amount in default over the past 12 months divided by the total outstanding volume at the beginning of the 12-month period. The shaded bars with top caps indicate periods of business recession as defined by the National Bureau of Economic Research: March 2001–November 2001 and December 2007–June 2009.

Source: S&P Global, Leveraged Commentary & Data.

On the eve of the COVID-19 outbreak, households were generally in sound financial condition; however, a substantial number of households will face increasing financial distress

The rise in unemployment in April demonstrates the severe shock to income and economic security many households face. Before this shock, households were generally in sound financial condition. Nonetheless, strains associated with the performance of household debt may worsen significantly and affect lenders throughout the financial system.

Borrowing by households had been rising in line with incomes in recent years...

Through the end of last year, household debt grew a bit less than income, with debt owed by households with prime credit scores accounting for most of the growth. Loan balances owed by borrowers with prime credit scores, who constitute about one-half of all borrowers and about two-thirds of all balances, continued to grow in the second half of 2019, surpassing pre-crisis levels (after an adjustment for general price inflation). By contrast, inflation-adjusted loan balances for the remaining one-half of borrowers with near-prime and subprime credit scores have changed little since 2014 (figure 2-8).

2-8. Total Household Loan Balances
Figure 2-8. Total Household Loan Balances
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Note: Subprime are those with an Equifax Risk Score below 620; near prime are from 620 to 719; prime are greater than 719. Scores are measured contemporaneously. Student loan balances before 2004 are estimated using average growth from 2004 to 2007, by risk score. The data are converted to constant 2019 dollars using the consumer price index.

Source: FRBNY Consumer Credit Panel/Equifax; Bureau of Labor Statistics, consumer price index via Haver Analytics.

. . . and mortgage borrowing poses less risk to the financial system than in the 2000s...

Mortgage debt accounts for roughly two-thirds of total household credit. Through the end of 2019, new mortgage extensions remained skewed toward prime borrowers, consistent with the general shift in the composition of household debt toward less-risky borrowers and in line with stronger underwriting standards relative to the mid-2000s (figure 2-9). Although many households face substantial losses in income, widespread forbearance measures should help damp the effect of COVID-19 on delinquencies, which were at low levels at the end of 2019 (figure 2-10). Relatively few borrowers had negative equity, a factor that will also serve to limit defaults (figure 2-11). While the severe decline in economic activity and tightening of lending standards originating from the COVID-19 pandemic might put downward pressure on house prices, the ratio of outstanding mortgage debt to home values at the end of 2019 was at the level seen in the relatively calm housing market of the late 1990s. Higher levels of homeowner equity generally reduce the likelihood of borrower defaults and would also provide lenders with a degree of protection against credit losses even as borrowers take advantage of forbearance measures, lessening concerns that a deterioration in lenders' balance sheets might impede future credit issuance and further worsen the economic outlook (figure 2-12).

2-9. Estimate of New Mortgage Volume to Households
Figure 2-9. Estimate of New Mortgage Volume to Households
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Note: Year-over-year change in balances for the second quarter of each year among those households whose balance increased over this window. Subprime are those with an Equifax Risk Score below 620; near prime are from 620 to 719; prime are greater than 719. Scores were measured a year ago. The data are converted to constant 2019 dollars using the consumer price index. Key identifies bars in order from left to right.

Source: FRBNY Consumer Credit Panel/Equifax; Bureau of Labor Statistics, consumer price index via Haver Analytics.

2-10. Transition Rates into Mortgage Delinquency
Figure 2-10. Transition Rates into Mortgage Delinquency
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Note: Percent of previously current mortgages that transition from being current to being at least 30 days delinquent each month. The data are three-month moving averages. FHA is Federal Housing Administration; VA is U.S. Department of Veterans Affairs. Prime and nonprime are defined among conventional loans.

Source: For prime and FHA/VA, Black Knight McDash data; for nonprime, CoreLogic

2-11. Estimate of Mortgages with Negative Equity
Figure 2-11. Estimate of Mortgages with Negative Equity
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Note: Estimated share of mortgages with negative equity according to CoreLogic and Zillow. For CoreLogic, the data are monthly. For Zillow, the data are quarterly and, for 2017, are available only for the first and fourth quarters.

Source: CoreLogic; Zillow.

2-12. Estimates of Housing Leverage
Figure 2-12. Estimates of Housing Leverage
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Note: Housing leverage is estimated as the ratio of the average outstanding mortgage loan balance for owner-occupied homes with a mortgage to (1) current home values using the CoreLogic national house price index and (2) model-implied house prices estimated by a staff model based on rents, interest rates, and a time trend.

Source: FRBNY Consumer Credit Panel/Equifax; CoreLogic; Bureau of Labor Statistics.

. . . although some households are struggling to manage their debt

The remaining one-third of total debt owed by households, commonly referred to as consumer credit, consists mainly of student loans, auto loans, and credit card debt (figure 2-13). Table 2 shows that consumer credit rose 4.5 percent over 2019 and currently stands at about $4 trillion.

2-13. Consumer Credit Balances
Figure 2-13. Consumer Credit Balances
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Note: The data are converted to constant 2019 dollars using the consumer price index.

Source: Federal Reserve Bank of New York Consumer Credit Panel/Equifax; Bureau of Labor Statistics, consumer price index via Haver Analytics.

Borrowers with subprime credit scores accounted for about one-fourth of outstanding auto loan balances as of the end of 2019 (figure 2-14). Despite the prolonged economic expansion and low interest rates, delinquency rates for auto loans to subprime borrowers have remained elevated for the past several years and are expected to increase further in response to the COVID-19 outbreak (figure 2-15).

2-14. Auto Loan Balances
Figure 2-14. Auto Loan Balances
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Note: Subprime are those with an Equifax Risk Score below 620; near prime are from 620 to 719; prime are greater than 719. Scores are measured contemporaneously. The data are converted to constant 2019 dollars using the consumer price index.

Source: Federal Reserve Bank of New York Consumer Credit Panel/Equifax; Bureau of Labor Statistics, consumer price index via Haver Analytics.

2-15. Auto Loan Delinquency Rates
Figure 2-15. Auto Loan Delinquency Rates
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Note: Delinquency is at least 30 days past due, excluding severe derogatory loans. The data are four-quarter moving averages. Subprime are those with an Equifax Risk Score below 620; near prime are from 620 to 719; prime are greater than 719. Credit scores are lagged four quarters.

Source: Federal Reserve Bank of New York Consumer Credit Panel/Equifax.

Consumer credit card balances were almost $1 trillion at the end of 2019, with subprime and near-prime borrowers, taken together, accounting for about half of that amount (figure 2-16). Delinquency rates for these two groups of borrowers could climb above the peaks of 2009 and 2010 given the sharp increase in the unemployment rate (figure 2-17).

2-16. Credit Card Balances
Figure 2-16. Credit Card Balances
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Note: Subprime are those with an Equifax Risk Score below 620; near prime are from 620 to 719; prime are greater than 719. Scores are measured contemporaneously. The data are converted to constant 2019 dollars using the consumer price index.

Source: Federal Reserve Bank of New York Consumer Credit Panel/Equifax; Bureau of Labor Statistics, consumer price index via Haver Analytics.

2-17. Credit Card Delinquency Rates
Figure 2-17. Credit Card Delinquency Rates
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Note: Delinquency is at least 30 days past due, excluding severe derogatory loans. The data are four-quarter moving averages. Subprime are those with an Equifax Risk Score below 620; near prime are from 620 to 719; prime are greater than 719. Credit scores are lagged four quarters.

Source: Federal Reserve Bank of New York Consumer Credit Panel/Equifax.

Finally, the already elevated delinquency rates on student loans highlight the challenges associated with debt payments for a number of households going into the pandemic. While a substantial number of households are facing, and will face, additional stress as a result of the pandemic, the risk that student loan debt, per se, poses to the financial system appears limited at this time; the majority of loans were issued through government programs, and the Cares Act guarantees payment forbearance and stops interest accrual until the end of September 2020.

 

References

 

 11. The dashed line in the series beginning in the first quarter of 2019 reflects a structural break due to a new accounting standard that requires operating leases, previously considered off-balance-sheet activities, to be included in measures of debt and assets. Return to text

 12. The box "Vulnerabilities Associated with Elevated Business Debt" in the May 2019 report gives a fuller description of risks associated with downgrades of credit ratings; see Board of Governors of the Federal Reserve System (2019), Financial Stability Report (Washington: Board of Governors, May), pp. 22–25, https://www.federalreserve.gov/publications/files/financial-stability-report-201905.pdfReturn to text

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Last Update: May 20, 2020