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The US economy is slowing, but US businesses have trillions of dollars in debt on their books. Is it a problem?
It all depends on the person asking the question or the metric used. In the first quarter of 2019, non-financial companies had more than $ 9 trillion in debt on their books, a record in dollar terms, according to Federal Reserve Fund flow data from St. Louis.
Meanwhile, investors continue to accumulate corporate debt. During the first quarter, buyers plowed nearly $ 102 billion in taxable bond funds, Morningstar data showed in April.
The current slowdown, which some fear, could become a recession, has been characterized by companies with record levels of high quality, high yield bonds, up to up to 46% of US gross domestic product and almost half of all global corporate debt outstanding.
This level is higher than before the Great Recession, according to a Deloitte analysis, which also found that corporate bonds grew on average by almost 7% per quarter between 2011 and the end of 2018.
With leverage at or near all-time highs, Goldman Sachs noted this week that corporate balance sheet fundamentals eroded in the first quarter. He added to the debate about the potential risks to the financial system, at a time when a global slowdown and trade disputes between major economies are scaring investors.
Goldman found that based on gross and net leverage, debt levels are higher than past highs reached in 2016.
However, “from a macroeconomic perspective, we continue to believe that historical comparisons that are based solely on measures of leverage overestimate the extent of the deterioration in credit quality,” the analysts wrote. in a research note to clients this week.
“In our opinion, these comparisons place too much weight on the ‘stock effect’ (that is, the accumulation of debt on balance sheets) and ignore the structural improvement of the ‘flow effect’ over the course of over the past two decades, ”the bank added.
High-yield, investment-grade, riskier issuers have seen their funding costs drop, in line with comparable Treasury bond yields which are near historically low levels.
Yet when combined with higher profit margins and hedge ratios, “we don’t think historically high leverage implies historically low credit quality,” Goldman said.
“Material deleveraging”
Despite trade war fears, corporate bond markets generated positive total returns in the second quarter, beating government bonds, the UK asset management company Schroders noted recently. US corporate debt returned more than 4% in the quarter ended in June, compared to 3.1% for government bonds.
Ironically, the recession that followed the 2008 crisis helped ease the relative financial health of U.S. businesses – with some help from the Federal Reserve’s unorthodox easing, which kept interest rates low.
In a recent analysis, bond rating firm DBRS noted that “there had been significant deleveraging following the global financial crisis, mainly reflecting the dramatic recovery in operating results through 2012, although from a very weak base ”.
Between 2013 and 2016, companies gradually took on debt as the global economy struggled – a move that ended up undermining operating profit and balance, DBRS noted.
During this period, the energy, manufacturing and mining sectors performed particularly well, against a backdrop of falling commodity prices and major metals.
“However, debt reduction has positioned these manufacturers well to maximize the benefits of deleveraging from the recovery in operating profits that began in 2017 and continued into 2018,” the rating firm said. “As a result, leverage has improved dramatically over the past two years.”
What could go wrong
A combination of massive bond purchases and near zero interest rates helped fuel the corporate debt boom. With interest rates likely to drop in the short term, the significant leverage effect of US companies is not yet considered a risk.
Still, signs have emerged that worry at least a few market watchers. Citigroup warned in June that several trends below the radar, including slowing earnings growth and increasing debt, suggested that credit markets were tightening.
And although companies like Tesla (TSLA) exploit the debt market, pillars of the bond market like Apple (AAPL), Oracle (ORCL) and Cisco (CSCO) has been roll back for at least a year.
The gap between junk bonds and investment grade paper has shrunk considerably, in part because of the strong demand for corporate debt.
Given the myriad of challenges facing the global economy, including the US-China trade war, geopolitical turmoil, and the downturn in major economies, the risk increases that credit markets will drive up costs. loan.
Speculative bonds, or junk, would most likely bear the immediate brunt of investor nervousness.
Deloitte economists recently pointed out that the percentage of quality titles bond is much lower at this stage of the US expansion compared to previous recoveries.
It highlights how “the share of bonds most likely to be downgraded to junk has increased,” Deloitte said.
“While short-term concerns about debt may subside if the economic outlook improves rapidly and interest rates remain under control, a lack of prudence in the use of borrowed funds may not be necessary. bodes well for businesses in the medium to long term, ”the company added.
Javier is an editor for Yahoo Finance. Follow Javier on Twitter: @TeflonGeek
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