Fed Flashes $1 Trillion Warning for Businesses Hit by Covid-19

The Federal Reserve and other bank regulators are flashing a new warning sign for the U.S. economy: Businesses ravaged by Covid-19 are sitting on $1 trillion of debt and a high percentage of it is at risk of going bust.

Watchdogs flagged 29.2% of complex corporate lending as troubled in 2020, up from 13.5% in 2019, according to a report released Thursday by the Fed and other agencies. Real estate, entertainment, transportation, oil and gas, and retail were cited as particular problem areas. A “disproportionate share” of the riskiest loans were held by nonbanks, such as investment funds that engage in leveraged lending, insurers and pension funds, the regulators added.

“While risk has increased, many agent banks have strengthened their risk management systems since the prior downturn and are better equipped to measure and mitigate risks associated with loans in the current environment,” the Fed, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency said in a statement that accompanied the release of their Shared National Credit Review.

Still, banks’ share of the weakest loans has also been rising, with some of their holdings -- particularly those associated with oil and gas -- facing credit downgrades during the pandemic, the report found. Banks’ percentage of borrowings deemed below the standards preferred by regulators increased to 45% from 35% a year earlier.

For their report, the Fed and other agencies evaluated $5.1 trillion in complex lending involving multiple firms, with half of it representing leveraged loans. Real estate, entertainment, transportation, oil and gas, and retail represented 21.6% of the lending that the regulators examined.

The 29.2% of “non-pass loans” highlighted in the report represent those the agencies categorize as meriting “special mention,” being substandard or at risk of triggering losses for lenders.

During the pandemic, the debt load involving leveraged lending -- borrowings by the riskiest companies -- has been on the upswing. In so-called syndicated loans backing U.S. acquisitions, leverage surged to at least a five-year high in the fourth quarter, according to Covenant Review.

Though bank regulators once insisted on limits for leveraged lending, those standards are no longer enforced. Nonbanks were never required to comply with the restrictions because such firms aren’t directly regulated by the Fed, FDIC and OCC.

©2021 Bloomberg L.P.

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