Moody's: High global corporate debt load signals future credit stress, despite benign near-term outlook

The record number of highly leveraged non-financial companies globally has set the stage for a particularly large wave of defaults when the next period of broad economic stress ultimately arrives, Moody's Investors Service says in a new report. The non-financial corporate debt burden today is higher than its peak before the 2008-09 financial crisis, although the near-term credit outlook is benign and the speculative-grade default rate remains low.

"The ranks of low rated issuers continue to swell due to easy market access in a stable credit environment where investors have been reaching for yield," said Mariarosa Verde, Moody's Senior Credit Officer and author of the report. "At the same time, the opportunity to borrow at low cost for mergers and acquisitions and to return capital to shareholders via dividends or share repurchases has proved irresistible for some investment-grade firms, leading some to adopt financial policy objectives that have led to lower ratings."

 

A decade of low growth and low interest rates has been a catalyst for formidable changes in non-financial corporate credit quality, Moody's says. Companies with speculative-grade ratings now account for 60% of all rated non-financial companies. About 40% of non-financial companies are rated B1 or lower. Meanwhile, the majority of investment grade companies are rated Baa, the category bordering speculative grade.

Downward pressure on investment-grade and speculative-grade ratings is evidenced by the steady increase in non-financial corporate leverage. For investment-grade firms, median debt/EBITDA today is around 30% higher than it was in 2007, while for speculative- grade companies it is up about 10%. For many speculative-grade issuers debt capacity may have reached its limit, although investor protections continue to weaken, Verde says.

The already very large population of speculative-grade issuers is likely to continue to grow before the next credit downturn, Moody's says. Global growth remains below pre-2008-09 levels, constraining the ability of central banks to anytime soon move forcefully away from accommodative monetary policies that favor leverage and leveraging transactions. Investor demand for higher yield continues to allow all but the weakest companies to avoid default by refinancing maturing debt. Some very weak issuers are living on borrowed time while benign conditions last.

The availability of credit and the overall increase in leverage at the speculative grade level has been facilitated by strong institutional investor demand for senior secured loans. The greater use of senior secured financing means that there is less junior debt cushion in speculative grade debt structures which raises the risk that in the next period of broad stress loan recoveries will be lower than they have been historically.

When defaults do eventually spike, credit losses are likely to be elevated, Moody's says. Today speculative-grade companies have some $3.7 trillion in rated debt outstanding, with B1 or lower rated debt accounting for about $2 trillion of this total.

Powered by Capital Market - Live News