Who’s afraid of US corporate debt?
- The level of total business debt has fallen as a proportion of GDP since the global financial crisis reflecting the deleveraging of financial companies.
- On aggregate, US non-financial corporate indebtedness has risen as a proportion of GDP, but remains subdued as a proportion of business income (net operating surplus) and has fallen as a proportion of profits.
- Moreover, with interest rates low, interest payments as a proportion of business incomes are still at decade-low levels.
- However, favourable conditions have encouraged many companies to adjust their capital structure which has seen borrowing from corporate debt markets increase 130% since the financial crisis.
- This has included a large increase in BBB-rated (and single A) issuance, leading to a modest deterioration in overall credit index quality.
- In the main, low interest rates make these debt structures affordable. And in stress-test scenarios, only in the most extreme cases do we envisage a deterioration in interest-cover ratios.
- Moreover, we expect recent developments (rising interest rates and Tax Reform changes) to result in a contraction of non-financial corporate debt growth over the coming years.
- We identify pockets of weakness in credit markets, where leverage is high and interest-cover ratios are low.
- Legitimate concerns over contagion risk are somewhat assuaged by relatively high corporate liquidity and the borrowing disintermediation over the past decade.
In the first paper in our series on US indebtedness we focused on public debt, concluding that the outlook, based on current policy, is for deficits of around 5% of GDP over the next decade. This outlook is alarming and we consider it unlikely that the US will adhere to this path. Instead, we consider it likely that a tighter fiscal outlook will emerge over the medium term, possibly if deficits widen further following any economic slowdown.
In this paper, we turn our focus to corporate debt. The Federal Reserve’s Flow of Funds report provides a breakdown of all business debt. It identifies financial and non-financial debt, corporate and non-corporate (Exhibit 2). Total business debt exceeded US$30tn in the second half of 2017 – a record high. However, this is only 153% of GDP, markedly lower than the 194% peak reached during the global financial crisis.
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