Corporate Debt Is Reaching Record Levels (#GotBitcoin?)
Highly leveraged companies could pose a threat to the global economy if rates rise or profits slump. Corporate Debt Is Reaching Record Levels
In the aftermath of the financial crisis, a swath of individuals and families began a long and painful deleveraging process.
Businesses, meanwhile, quickly moved in the opposite direction—loading up on cheap debt to the point where many observers now worry that highly leveraged companies pose a threat to the global economy.
U.S. corporate debt has climbed to roughly 46% of gross domestic product, the highest on record, according to data from the Federal Reserve and Commerce Department. Businesses in emerging markets, such as China, have gone on an even bigger borrowing binge, taking advantage of ultra-low interest rates and, in some cases, state-driven policies designed to propel economies forward.
So far, businesses have been able to service their debt without too much difficulty. The concern is that could change if interest rates continue to rise, making debt more costly, or if the economy slows, crimping profits.
In the U.S., leverage levels have climbed for both larger and smaller businesses. With the economy apparently on solid footing, ratings firms have often allowed larger companies, such as CVS Health Corp. and Campbell Soup Co. , to load up on debt to fund acquisitions without taking away their investment-grade ratings. That has contributed to a large expansion in the amount of corporate bonds rated in the bottom tier of the investment-grade spectrum, a trend some analysts worry could be giving investors a false sense of security about the safety of their holdings.
Among midsize businesses, there is has been an uptick in so-called direct lending in which business obtain loans from nonbanks, many of them private-equity firms, with traditional banks playing little part in the process. Nonbanks held more than half a trillion dollars worth of loans to midsize companies at the end of 2017, up from roughly $300 billion in 2012, according to estimates by private-equity firm Ares Management LP.
Not surprisingly, some banks that have long relied on commercial lending have concerns about the growing role of nonbank lenders. Some have warned that their experience will be missed in the next downturn when businesses will be more at the mercy of “distant credit investors,” as the chief executive of Buffalo, N.Y.-based M&T Bank Corp. , René Jones, recently wrote in a letter to shareholders.
Whether or not the banks have a case, it is certainly true that high corporate debt levels pose risks to investors, as well as businesses. Making the threat more severe, most recently issued bonds and loans to even the lowest-rated businesses carry minimal protections for investors, known as covenants.
While that could help businesses forestall bankruptcy in the short term by giving them greater leverage over investors, it also could cause their debt to be worth less in the long run, as businesses find it easier to do things like strip assets from lenders.
Soaring Corporate Debt Levels Threaten Financial Stability, IMF Warns
The global financial system is at risk from ballooning levels of corporate and emerging market debt caused by ultra-low interest rates, the International Monetary Fund (IMF) has warned.
The IMF cautioned that in a downturn half as severe as 2008, $19 trillion (£14.9 trillion) of companies’ debt – “above crisis levels” – is at risk of default and poses the threat of global contagion.
The US-China trade war and a global slowdown mean already very low interest rates are set to stay “lower for longer,” the international lender of last resort said today in its biannual financial stability report.
Low rates have held down government bond prices and sent investors towards riskier assets such as non-financial firms’ bonds and shares and the debt of emerging market countries. The amount of money owed by companies and developing countries has rocketed.
The IMF, which is in the middle of its first annual meeting under new chief Kristalina Georgieva, today cautioned that an economic downturn could severely limit the ability of these firms and countries to pay their debts as earnings fall and lenders demand higher interest.
This “could have significant macroeconomic implications,” the Fund said. A failure by firms to pay up would rock institutional investors such as pension funds that hold their bonds and the damage could spread through economies.
“Similarities in investment funds’ portfolios could magnify a market sell-off, pension funds’ illiquid investments could constrain their ability to play a role in stabilising markets as they have done in the past, and cross-border investments by life insurers could facilitate spillovers across markets,” the IMF said.
Investors have also snapped up the bonds of emerging market countries such as Brazil, India and Mesico which offer bigger returns, leading to high levels of sovereign debt.
“In the event of a sharp tightening in global financial conditions, increased borrowing could raise rollover and debt sustainability risks,” the Fund said.
It said the main focus of governments should be bringing an end to the trade tensions which are the primary “downside risk” to the economy.
n its economic outlook report yesterday, the IMF predicted that the US-China trade war would push global economic growth down to just three per cent this year, its lowest rate since the financial crisis.
The Fund also called on governments to tackle high corporate debt burdens. “Efforts should be made to increase disclosure and transparency in non-bank finance markets to enable a more comprehensive assessment of risks,” it said.