There’s been endless speculation in recent weeks about whether the U.S., and the whole world for that matter, are about to sink into recession. Underpinning much of the angst is an unprecedented $29 trillion corporate bond binge that has left many companies more indebted than ever.
Whether this debt overhang proves to be a catalyst for recession or not, one thing is clear in talking to credit-market observers: It’s a problem that won’t go away any time soon.
Strains are emerging in just about every corner of the global credit market. Credit-rating downgrades account for the biggest chunk of ratings actions since 2009; corporate leverage is at a 12-year high; and perhaps most worrisome, growing numbers of companies -- one third globally -- are failing to generate high enough returns on investments to cover their cost of funding. Pooled together into a single snapshot, the data points show how the seven-year-old global growth model based on cheap credit from central banks is running out of steam.
“We’ve never been in a cycle quite like this,” said Bonnie Baha, a money manager at DoubleLine Capital in Los Angeles, which oversees $80 billion. “It’s setting up for an unhappy turn.”
While not as pronounced as the rout in global equity markets, losses are beginning to pile up in the bond market too. The average spread over benchmark government yields for highly rated debt has widened to 1.83 percentage points, the most in three years, from 1.18 percentage points in March, according to Bank of America Merrill Lynch indexes. Investors lost 0.2 percent on global corporate bonds in 2015, snapping a string of annual gains that averaged 7.9 percent over the previous six years, the data show.
Debt at global companies rated by Standard & Poor’s reached three times earnings before interest, tax, depreciation and amortization in 2015, the highest in data going back to 2003 and up from 2.8 times last year, according to the ratings company. Total debt at listed companies in China, the world’s second- largest economy, has climbed to the highest level in three years, according to data compiled by Bloomberg.
Worsening debt profiles contributed to S&P downgrading 863 corporate issuers last year, the most since 2009. More than a third of commodity and energy companies have ratings with negative outlooks or are on credit watch with negative implications, S&P said. Almost 6 percent of U.S. corporate bonds were downgraded through the third quarter, the largest proportion since 2009, according to Fitch Ratings.
Much of the cheap credit accumulated by companies was spent on a $3.8 trillion M&A binge, and to fund share buybacks and dividend payments. While that tends to push up share prices in the short term, bond investors would rather see that money spent on strengthening the business in the long term.
Different Climate
“It’s an indication we’re in a different climate of expansion, rather than prudence, that targets shareholders and leverage,” Jeroen van den Broek, head of developed-markets credit strategy and research at ING Bank NV in Amsterdam, said. “It’s detrimental to credit holders.”