The aggregate debt load of U.S. corporations has surged above $9 trillion and equals more than 45% of U.S. GDP, CNBC reports, a worrisome development in the face of rising interest rates and decelerating economic growth. Former Federal Reserve Chair Janet Yellen sees broad systemic risks. She warns that high corporate debt could "prolong" an economic downturn and set off a wave of bankruptcies. This, in turn, would have a devastating impact on the stock market.
Meanwhile, automotive giants General Motors Co. (GM) and Ford Motor Co. (F), plus industrial conglomerate General Electric Co. (GE), may face the highest refinancing costs among investment grade companies in 2019, per research by CreditSights reported by Barron's. They had total debt loads of $102 billion, $154 billion and $115 billion, respectively, as of the quarter ending Sept. 30, 2018.
Significance For Investors
"What investors really need to do is make sure they're starting to look at balance sheets and cash flows. Look at those levels of debt and their ability to pay off the interest expense," Lindsey Bell, an investment strategist at CFRA Research, told CNBC.
Since 2008, the year of the financial crisis, corporate debt grew by $2.5 trillion, an increase of 40%, per data from the Federal Reserve Bank of St. Louis cited by Forbes columnist and investment advisor Jesse Colombo. It also has roughly doubled since the peak of the dotcom bubble in 2000, and is higher than ever relative to GDP.
This debt explosion has been facilitated by the Federal Reserve's policy of quantitative easing (QE), initiated to combat the 2008 crisis, which sent interest rates down to historic lows. As a result, Barron's calculates that, while corporate debt more than doubled, interest payments on it rose by less than 40%. But the Fed is reversing QE, which will send interest rates upward. Absent growing revenues, companies may have to meet rising debt servicing costs by cutting capital investment, thus jeopardizing future growth, or by reducing share repurchases, removing a major prop to their stock prices.
As a direct result of their high leverage, GM, Ford or GE might have their bond ratings downgraded to high yield or junk bond status, Barron's indicates. Not only would this increase their own borrowing costs, but it may disrupt the $1 trillion high yield bond market. which attracts different buyers than investment grade debt, given its greater risk.
Increasing the value of high yield debt outstanding by $100 billion or more (that is, by 10% or more) would send interest rates on these bonds upward, increasing borrowing costs for many smaller and less creditworthy companies. This, in turn, will reduce their earnings and send their share prices tumbling.
Former Federal Reserve Chair Alan Greenspan is among those who see a dangerous bond market bubble created by QE, as reported by Investopedia. As this bubble deflates, he cautions that stock prices also will be dragged down.
Jesse Colombo wrote in Forbes: "Loose monetary conditions are what created the corporate debt bubble in the first place, so the ending of those conditions will end the corporate debt bubble. Falling corporate bond prices and higher corporate bond yields will cause stock buybacks to come to a screeching halt, which will also pop the stock market bubble, creating a downward spiral."
Stockholders and bondholders alike in highly leveraged companies, among them GM, Ford and GE, should review the risks, which include possible downgrades by debt rating agencies and debt servicing squeezes. Investments in the debt or equity of more creditworthy firms also are at risk, if a general market crisis ensues from a deflation of the bond bubble, or a string of corporate bankruptcies.