The Current State of American Corporate Debt
By Guest Author: Professor Arthur S. Guarino, MBA, MSSc, JD, Rutgers University
The amount of corporate debt in the United States is growing at an alarming pace. While issuing debt has its good and dangerous sides, too much debt has been accruing with American companies due to numerous reasons. The problem then becomes how will the American economy be affected in case of an economic downturn.
The recent ten years have been a period of financial complexity for the American economy. For one part of the United States, wages have not grown at a pace reflecting the nation’s recovering macroeconomy. For another segment, the stock market, represented by either the Dow Jones Industrial Average (DJIA) or the S&P 500 Index, have show phenomenal growth that has made Wall Street and its investors extremely wealthy. But a problem that has remained silent is the increasing amount of corporate debt. Due to a number of key reasons, corporations have been extending their use of debt to keep not only creditors at bay but also to have happy shareholders. While the American economy is experiencing healthy growth, the real problem is what will happen to the macroeconomy if there is a unforeseen event or a sudden downturn that causes these corporations to renege on their loan obligations?
How much corporate debt is there?
The amount of corporate debt has seen sizeable increases in the past ten years. In 2007, total corporate debt stood at approximately $4.9 trillion. But according to a report by McKinsey and Company, nonfinancial corporations total liabilities, including bonds and loans, grew by $37 trillion in reaching $66 trillion by mid-2017. However, with regards to other segments of debt, the value of corporate bonds outstanding from non-financial corporations has almost tripled to $11.7 trillion. With this increase in debt comes significant problems. For example, more companies are having difficulties meeting their debt obligations. According to the Institute of International Finance, Incorporated, a trade group representing financial institutions, approximately 17 percent of publicly-traded American corporations were having difficulties meeting interest obligations at the end of 2018 which is an increase from 2010 of less than 10 percent but lower than the high in 2016 which exceeded 20 percent.
From another financial perspective, the amount of corporate debt is seeing dangerous levels. According to S&P Global, the ratio of cash-to-debt for speculative-grade borrowers has gone to a ten-year low of 13 percent from 21 percent in 2010 and even below 15 percent in 2008 in the time of the Great Recession. S&P Global reached the conclusion that speculative borrowers are faced with debt of almost $8 for every $1 of cash. Even for higher rated debtor corporations that are investment grade, the cash-to-debt ratio is at a low of 21 percent or $5 of liabilities for every $1 of cash they hold. As long as the economy is stable and growing, this is not much of a problem. But if a recession were to occur, these corporations will face a severe debt crisis.
How it got this way
There are some key reasons in how the American corporate debt situation reached this stage. First, there is the economic growth of the United States since the Great Recession. With the American economy in much better shape than before, rating firms such as Moody’s and Standard and Poor’s have given companies such as CVS Health Corporation and Campbell Soup Company higher credit ratings which permits them to increase their debt load without diminishing their investment grade standings. These companies can attract new investors with the lure of good credit ratings and lower risk. The problem is that investors may be getting a false sense of security regarding the safety of their bond holdings. But with investment grade ratings, investors feel they are immune from any possible financial disasters and lend more than they should.
Another key reason is that interest rates have been at low levels since the period of the Great Recession. For example, according to Moody’s Seasoned Aaa corporate bond yield as of April 11th, 2019 the rate was 3.68 percent while on April 21st, 2014 the rate was 4.26 percent. According to the St. Louis branch of the Federal Reserve Bank, the 10-year high quality market corporate bond spot rate as of January 1st, 2019 was 4.15 percent while on January 1st, 2009 it was 6.87 percent. Currently, the average small business loan interest rate varies from 4 to 6 percent. Cheaper rates entice corporations, large or small, to borrow more even to the point of over-extending themselves.
Another problem is that even with the average quality of borrowers declining, the amount of debt is going up since lenders are enticed by higher interest rates. The problem the United States is experiencing is that 22 percent of outstanding non-financial corporate debt falls into the category of “junk” bonds while 40 percent have a rating of BBB which is one step above junk status. As of December 2018, the amount of BBB rated debt in the United States was approximately $2.5 trillion. The problem here is that these bonds while offering higher interest rates to bondholders have an above average chance of defaulting if the issuer hits bad financial times or if the macroeconomy enters a recession.
Another area of corporate debt that has seen significant growth are syndicated leveraged loans. Leveraged loans are made to companies experiencing a high amount of debt made by commercial banks and then sold or syndicated to nonbank investors. These investors purchase the loans and put them into special-purpose vehicles known as collateralized loan obligations (CLOs) as well as private equity funds. According to the Federal Reserve Bank of Dallas, the market size of syndicated leveraged loans has gone from $0.6 trillion in 2008 to $1.2 trillion at the end of 2018. These funds have been used as financial backing for corporate acquisitions and private-equity-backed transactions. The problem is that as these loans increase so may the chance of default in case of an economic downturn.
Benefits of debt
Despite the problems that debt may bring, there are some benefits for issuing companies.
- Diversification: Debt allows a corporation to diversify in how it acquires its financial capital. A corporation can offer bonds or borrow money from different sources and not be concerned about going to the same source for cash again and again. This is important since some potential lenders may not have enough money to lend or have stopped lending altogether. Also, a corporation can issue debt and not have to go to stockholders, either common or preferred, repeatedly to ask for additional cash.
- Reduced need for bank loans: A significant benefit for issuing debt, especially bonds or long-term notes, is that an issuing corporation does not need to approach commercial banks for funds. Not only does this help the borrowing corporation diversify its sources of financial capital, but also use banks as a backup source of financial capital for short and long-term loans. Issuing bonds or notes may also be a cheaper source of financial capital for corporations since the interest rate may be lower than a bank loan and have reduced costs.
- Sell bonds domestically or globally: A significant benefit for a corporation issuing debt, either bonds or notes, is that it can seek lenders domestically or globally. A corporation located in the United States can sell its bonds or notes anywhere in the country in order to diversify its investor base. But that same corporation can also go into foreign markets and attract international investors in its bonds and notes to further diversify its investor base. It also benefits these foreign investors so they can further diversify their portfolio. These foreign investors could also get a higher return on these bonds and notes than they possibly could in their own country. Finally, if the interest and principal are paid in American dollars, these foreign investors can obtain U.S. currency and minimize currency transaction costs.
- Acquire capital from finance companies: The issuance of bonds or notes can allow a corporation to acquire financial capital from finance companies. There are many finance companies, domestically and internationally, that will purchase bonds and notes and either hold them or sell them to clients. Selling bonds or notes to finance companies allows issuing corporations to diversify their investor base, possibly get lower interest rates on the debt, and issue debt at a lower cost.
- An annuity for investors: Issuing bonds can actually help investors such as private individuals who are looking for an annuity. Private investors who are in retirement age can purchase investment grade bonds offering greater safety than junk bonds or lower rated financial instruments. Not only do private individuals need bonds as an investment vehicle but also mutual funds, pensions, and insurance companies.
Key risk of debt
While debt issuance has its benefits for issuing corporations and investors, there are also risks. Foremost among these risks is that the issuing firm may be overextended. A significant problem for any corporation issuing debt is that it may overextend itself and issue too much. Due to lower interest rates, a healthy macroeconomy, and its high credit rating a corporation may go beyond the amount of debt it would normally raise. The problem here is that a corporation may have a difficult time repaying the debt if the economy takes a downturn or it may suffer financial problems it did not anticipate. But overextending their debt situation is an important concern that will not only affect the issuing corporation but also the debt holders as well as common and preferred shareholders.
What happens next?
As long as the American economy stays relatively healthy, then its corporate debt situation is sustainable. Corporations will be able to make their interest payments to lenders and these lenders will enjoy healthy cashflow into the foreseeable future. But if there is the long-awaited downturn in the macroeconomy or a black swan that suddenly appears causing the American economy to go into a recession, then these debt instruments could become worthless overnight and have a ripple effect that will be worse than has ever been experienced. This will result in pension funds missing payments to pensioners, mutual funds reducing or skipping interest payments to shareholders, and insurance annuities going bankrupt.
Arthur Guarino is an assistant professor in the Finance and Economics Department at Rutgers University Business School teaching courses in financial institutions and markets, corporate finance, investments, and financial statement analysis. The first half of his career was spent in the financial services industry working for corporations such as TIAA-CREF, Met Life, and The Bank of New York. He writes articles dealing with finance, economics, and public policy.
5-year economic forecasts on 30+ economic indicators for more than 130 countries & 30 commodities.
Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinion of FocusEconomics S.L.U. Views, forecasts or estimates are as of the date of the publication and are subject to change without notice. This report may provide addresses of, or contain hyperlinks to, other internet websites. FocusEconomics S.L.U. takes no responsibility for the contents of third party internet websites.
Date: April 25, 2019
TagsGermanyG7Eastern EuropeChinaMajor EconomiesTradeForexEuro AreaCommoditiesItalyTurkeyInfographicCryptocurrencyUKUnemployment rateSpainEnergy CommoditiesFranceMENASub-Saharan AfricaJapanVenezuelaRussiaUnited StatesArgentinaIndiaPortugalprecious metalsLatin AmericaBrexitEuropean UnionAgricultural CommoditiesAfricaBrazilAustraliaOPECIMFHealthcareBanking SectorOilEurozoneMexicoInflationEconomic Growth (GDP)USAGoldoil pricesTPPUnited KingdomGreeceBase Metals CommoditiesAsiaColombiaHousing MarketBitcoinEmerging MarketsCompany NewsPrecious Metals CommoditiesVietnamCanadaUkraineExchange RateIranTunisiaConsensus ForecastSouth AfricaEconomic DebtInvestmentNordic Economies
Sub-Saharan Africa: Growth to gain traction in 2019 - https://t.co/2kq2hPjLI6
4 hours ago
We'd like to congratulate all the winners of the 2019 Analyst Forecast Awards, which recognize the top economic for… https://t.co/oPZptBcS8P
6 hours ago
Hold-ups to ratifying the USMCA, coupled with a possible slowdown in the U.S., cloud Mexico's outlook, as does an o… https://t.co/xmLcowrkes
8 hours ago
An expected rally in precious metal prices in 2019 is projected to continue in 2020. Find out more: https://t.co/7XITZDvWA8
10 hours ago
FocusEconomics analysts expect Latin America's economy to expand 1.9%, down 0.2 percentage points from last month's… https://t.co/T755DKIEya
10 hours ago
- Which will be the most miserable economies in 2019?
- Only by freeing Nigeria from its dependence on oil can Buhari truly take Africa’s giant to the next level
- An Analysis of President Trump’s 2020 Budget
- The World's Fastest Growing Economies
- President Sebastian Piñera aims to bring his elder brother’s private pension system into the 21st century
- Brexit Scenarios: Consensus of 14 Economic Analysts
- Sweden just formed a new government and approved its 2019 budget: what does it mean for the economy?
- Which countries have the highest public debt levels?
- Predictions for the global economy in 2019 from 13 experts
- Gurdgiev: Predictions for the global economy in 2019
- Daniel Lacalle's ideas for 2019: Change of cycle.
- Vietnam Poised to Profit from Free Trade Agreement Opportunities
- Canada in 2019: Interview with a Top Economic Forecaster
- Pound Sterling 2019 Exchange Rate: Projections from Leading Analysts
- Expectations for Latin America’s Economy in 2019
- Ethiopia and Rwanda: From Destruction to Development
- Key commodities trends to look out for in 2019
- What drove Gulf neighbors to bail out Bahrain?
- The Four Financial Bubbles and Their Impact on the U.S. Economy
- The Poorest Countries in the World
- Italy: The sick man of Europe
- What does Bolsonaro's presidential win mean for Brazil's economic outlook?
- The World's Top 10 Largest Economies
- In Latin America, taxpayers are tapped to shoulder the burden of a bank bailout
- How and when will the next financial crisis happen? - 26 experts weigh in
- China and Africa: A partnership under the spotlight
- The conditions are ripe for a Global Financial Crisis 2.0
- Uncertainty, instability and fear haunt a generation of Argentinians
- 5 things: What to expect for Mexico's economy in 2019
- 5 things: Brazil's economic downturn and what to expect going forward
- Emerging Market Currency Crisis: Everything you need to know
- Which ASEAN countries are most exposed in the event of a U.S.-China trade war?
- 75 Top Economics Influencers to Follow
- Emerging Markets Economic Outlook 2018 and 2019
- The Faces Behind Latin America’s Key Institutions
- 2019 Economic Outlook for the Top Oil Producing Countries
- Is your cup of coffee about to get more expensive going in to 2019?
- The Economic Implications of an Aging Global Population
- Can the Wisdom of the Crowds predict the results of the 2018 World Cup?
- Railway Mania: The Largest Speculative Bubble You’ve Never Heard Of
- From Riches to Rags: Have Cryptocurrencies Crashed for Good?
- Investment looks to Latin America, but forecasts are not encouraging
- Turkey: Erdogan has cemented his grip on power - now what about the economy?
- How can Latin America’s business environment benefit from technological change?
- Mexico: A look at the past, present and future as elections yield AMLO victory
- Italy’s New Populist Government and the Eurozone: Prelude to a Crisis?
- Latin America moves toward increased integration as U.S. protectionism grows
- How can Latin America increase productivity without affecting the quality of employment?
- How will Saudi Arabia's economy benefit from lifting the women's driving ban?
- Which countries are the most prepared for the upcoming digital revolution?
- India Under Pressure from the U.S. on Trade Policy
- The Story of Steel
- Latin America is the World Leader in eCommerce Growth Despite Serious Challenges
- What the TPP means for trade in Latin America
- Elections in Russia: Analysis and Implications
- Nearly a Third of Latin Americans Have No Right to a Pension
- A Look at Healthcare Models Around the World
- Newly-elected Chilean President Sebastian Piñera faces a myriad of challenges - economic and otherwise
- The Economic Effects of Trade Protectionism
- Regional Disparity: The Dark Side of Inequality in Latin America
- Coal: The story of the world's most abundant fossil fuel
- Venezuela's Electoral Conundrum
- Gold: The Most Precious of Metals (Part 3)
- Trump's 1st Year: 95 Analysts Surveyed on U.S. Economy
- The Latest on China and What's in Store for 2018
- An in-depth look at the Eurozone’s booming economy and the challenges that lurk in the shadows
- Increasing poverty in Latin America takes a breather thanks to improving economic dynamics
- Is Spain doing enough to address its high youth unemployment rate?
- Has Latin America gone far enough in reducing barriers to international trade?
- Commodities Outlook: Oil, Natural Gas, Coal, Lead & Tin
- 21 experts tell us what the future looks like for cryptocurrencies and blockchain
- Turkish lira plummets to all-time low on Erdogan’s monetary feud and tense U.S.-Turkey relations
- Copper: The first metal mastered by man
- The Mercosur-EU Free Trade Agreement: Obstacles & Opportunities
- Nigerian Economy Still Treading Water Thanks to Oil Sector
- Elections in Chile: What the results could mean for the economy
- QE’s Untold Story: A Chart That Fed Correspondents Need To Investigate
- Holland’s fragile one-seat majority government targets economic growth at the expense of fiscal sustainability
- South Africa: Economy at a tipping point?
- Latin American Commodities: What’s behind the increase in demand and prices?
- Is the UK really "shackled to a corpse"?
- Spain-Catalonia: 7 economic experts weigh in on how the situation will affect the outlook
- How well is Spain's labor market doing since the crisis?
- Which countries will have the highest and lowest inflation in 2017?
- How vulnerable is Latin America to economic crises today?
- Iron ore facts and common questions answered
- The bulging economic costs of obesity
- How much investment is needed to salvage Latin America’s crumbling infrastructure?
- A Look at the Potential Impact of Brexit on the Dutch Economy
- Emerging Markets Are Kicking Into Higher Gear In 2017
- Why is foreign direct investment in Latin America falling again?
- Are Central Banks Nationalising the Economy?
- Bounty or burden? The impact of refugees on European economies is far from clear
- What’s the future of U.S.-Latin America trade relations?
- Taxes or cutbacks? Latin America's challenge of sustaining spending without causing debt to skyrocket
- Are uranium prices making a comeback?
- Taxing the Economy: Achieving a Delicate Balance
- How will Latin America’s upcoming lengthy election cycle affect the reform agenda and credit ratings?
- How will emerging market economies perform in 2017?
- Chilean Economy in Focus: Interview with Senior Economist of the Chamber of Commerce of Santiago
- CEOs Rank Top Economies for Growth Opportunities
- The Mobile Ecosystem & Latin America's Economy
- Prospects and Challenges for the Global Economy: Interview with Tim Cooper from BMI Research
- How will the Fed reduce its balance sheet & and how will the ECB end QE? - 19 economic experts weigh in
- Thoughts on "unwinding" QE from Frances Coppola
- The Fed and ECB at a crossroads: Unwinding QE
- Spain: The economy that continues to silence the critics
- Latin America: The Most Unequal Region in the World
- The History of OPEC: Has it been a Success?
- FocusEconomics Announces 2017 Analyst Forecast Awards Winners
- Latin America’s rising unemployment bucks nearly decade long trend
- Escape from the Central Bank Trap by Daniel Lacalle
- China's economic rebalancing act: What to look out for in 2017
- Driving Growth in Latin America: Challenges & Priorities
- Is the Global Economy Rebalancing?
- Commodity exporters face challenging times
- Recent Global Events Facilitate Mercosur-Pacific Alliance
- 23 economic experts weigh in: Why is productivity growth so low?
- Mexico's outlook as Trump nears 100-day mark
- Interview with Oxford Economics Senior Economist on implications of the possible outcomes of the French Presidential Election
- The anxiety of the small saver in a world of negative interest rates
- Brexit negotiations. Between Uncertainty and Urgency
- An Economic History of the EU from El Blog Salmón
- Baby Boomin': Implications of high population growth in Latin America
- Survey of International Economists Predicts a Le Pen Defeat in French Elections, Says Macron has Best Economic Plan
- Spain in a global context: developed economy with some challenges
- How much is crime costing Latin America?
- Predictions & Estimates from Economist Daniel Lacalle
- What economy will the new Dutch government inherit?
- “The data is not a true reflection of reality in India” Interview with Société Générale India Economist
- What are the prospects for Emerging Economies in 2017?
- What to expect in Asia for 2017
- Top Economics & Finance Blogs of 2017
- Latam to Resume Moderate Growth in 2017 but Important Risks Plague Outlook
- 4 Key European Elections That Will Impact the Economy in 2017
- How are security concerns and political chaos affecting Turkey’s economy?
- Global growth to edge up in 2017
- Set to breach targets again? Debt and deficit outlooks for Southern European Eurozone countries in 2016 & 2017
- What does Donald Trump mean for the U.S. economy?
- How will emerging markets perform in 2017?
- The economic impact of a break in U.S.-Philippines ties
- Trump election: Base metals surge due to infrastructure plan
- 5 updates on the Venezuelan economic crisis
- Canada: When your neighbor’s house is on fire…
- Short-term pain before long-term gain? A look at French labor reform and economic growth
- Asia: Unremarkable growth & unfulfilled promises?
- How India's latest monsoon is affecting the economy
- Innovation in Latin America: Potential Goes Untapped Due to Weak Economic Conditions
- Russian economy update in wake of OPEC deal announcement
- The Wisdom of the Crowds and the Consensus Forecast
- Can the peso predict the U.S. election results?
- There's no end in sight to the Venezuela crisis
- A Look at the European Union Political Calendar
- Survey of international economists shows uncertainty surrounding elections damaging U.S. growth prospects
- FocusEconomics partners with leading online statistics provider Statista
- China: Recent postive economic data may be papering over the cracks
- Sub-Saharan Africa's 2016 & 2017 growth rates
- The Italian Dilemma: Weak banks pose risk to already faltering domestic demand
- How much money do migrants from Latin America send home?
- The U.S.' (Not So) Mysterious Case of the Missing Men
- What to expect from the G20 economies by 2020
- The Pain in Spain: Robust GDP growth cannot mask the persistent structural deficit