Credit risks persist, especially in energy: U.S. monitor

WASHINGTON (Reuters) - Credit risks continue to mount in the U.S. financial system, even in the energy sector which recently saw some improvement, the head of the agency focused on the country’s financial stability said on Wednesday.

Office of Financial Research Director Richard Berner is interviewed at the Reuters Financial Regulation Summit in Washington, US May 18, 2016. REUTERS/Gary Cameron

In December, the Office of Financial Research said high rates of borrowing by businesses had elevated credit risk to a level possibly hazardous to the U.S. financial system’s health.

Five months later, the office’s director, Richard Berner told the Reuters Financial Regulation Summit in Washington they “have mounted a little bit” since then.

“The fundamentals are still that growth is very slow in many parts of the world and companies - particularly non-financial corporates here and in some emerging markets - have taken on more risk,” he said.

Berner added that typical recovery rates for defaulted debt “are in the neighborhood of 30 to 50 percent” but “we saw them come down a lot in the first quarter.” That could possibly shock investors expecting to recoup money when loans go sour.

The energy sector remains a credit risk, too, despite rising oil prices. Companies may still not generate the income needed to service high levels of debt they took on in recent years.

“The cash flows that they now can expect are better than when oil was, you know, 25 bucks for a short period of time, so that’s a lot better,” he said. “But the fact is that the debt didn’t go away.”

Banks that lend to energy producers have mostly managed for risks, he added.

“Have they managed for them sufficiently? I think you’d have to look bank by bank,” Berner said. “The important point is that the bulk of those loans weren’t made by banks. They were made in the securities markets, in the capital markets.”

U.S. crude oil prices have recovered from a 12 year low around $26 a barrel last December to nearly $50 this week.


The Office of Financial Research, created by the Dodd-Frank Wall Street reform law of 2010, will soon release a report on securities lending, Berner said, adding current gaps in data “prevent us from making a reasoned and analytical assessment of where the risks might.”

It is also looking at whether clearing houses for swaps could create “contagion risk,” he said.

Regulators are working toward stress testing central counterparties along the same lines as banks, which much show how they could withstand hypothetical situations without government assistance.

Debate revolves around whether “stress tests should be uniform” or “tailored to the bespoke kinds of risks” in individual clearing houses, he said.

“The answer is both.”

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Reporting by Lisa Lambert and Lauren Tara LaCapra