Corporate debt rises as the economy struggles
JUN. 16, 2020
Companies have taken advantage of the low interest rate environment over the past decade to increase their debt loads. Much of this debt was used for expansions, acquisitions and share repurchases, and investors didn’t penalize many corporate borrowers for the added leverage or lower credit ratings.
This trend has accelerated this year, even in light of the devastating economic decline. Corporate debt issuance in the first five months of 2020 topped $1 trillion, nearly matching the total for all of 2019.
Rising debt levels have not led to higher borrowing costs, as the Federal Reserve’s words and actions have kept credit spreads at near-historic averages despite the economic downturn. This may become an issue, despite the low rate environment, as corporate profits and cash flows deteriorate. Currently, an estimated 18% of U.S. companies have debt servicing costs that are above their profits for the past three years. That number is up from 3% before the financial crisis.
As earnings decline, more firms are likely to see their debt-servicing costs rise. Accordingly, corporate defaults are poised to increase. For bond investors, that means selectivity will become more critical to uncover opportunities for sustainable yields. For equity investors, careful analysis of balance sheets will become more vital.
Review relevant client material from Nationwide