Semantron 23 Summer 2023

US corporate debt

Economist in 2019 that reviewed the balance sheets of publicly traded American non-financial firms (e.g. General Motors and Apple), which currently account for $9.6 trillion of America’s total corporate debt. 14 It was found that their ‘combined earni ngs before interest and tax were big enough to pay the interest on this debt mountain nearly six times over’ , 15 maybe showing why companies aren’t too worried about their debts. So why should we be worried? Of the $9.6 trillion of debt these non-financial firms have accumulates, about $1 trillion is from firms with debts greater than four times their earnings before interest, tax, depreciation and amortization (EBITDA); and interest bills that ‘eat up at least half their pre - tax earnings’. 16 This pool of more risky debt has grown at a rapid rate, with it roughly being the same size as subprime mortgage debt was in 2007, both in absolute terms and as a share of the broader market in which it sits. 17 However, focusing on the market for so-called ‘leveraged loans’ (a type of loan that is extended to companies or individuals that already have considerable amounts of debt or a higher risk of default) 18 creates further concern over the American corporate debt mountain. The stock of these loans has grown sharply in America over recent years. They now rival junk bonds (bonds issued by companies that are not in a good financial state and therefore have a high risk of default) for market size at $3 trillion; 19 and unlike bonds, which offer a fixed return, interest rates on leveraged loans typically bob up and down. 20 Investors are therefore attracted to the riskier corporate debt because it pays higher returns than the very low returns they can receive on safer debt, but are at a high risk of default. Howev er, Europe’s leveraged -loan market is much smaller, about $300 billion in size, 21 making it ten percent of the US market. The rapid growth of leveraged loans is what most worries people about the growth in corporate debt. Similar to Jerome Powell, many pol icymakers have voiced their concern over America’s corporate debt, including Janet Yellen, Powell’s predecessor at the Fed, Lael Brainard, another Fed policymaker, and the IMF. 22 These worries are mostly based on three characteristics: deteriorating quality of credit, securitization, and insufficient regulatory oversight; all too familiar from the subprime-mortgage boom. Firstly, deterioration in the quality of credit has been seen through the growing proportion of leveraged loans issued without covenants (independent agreements made between a borrower and a lender which includes a promise from the borrower to remain financially sound for the duration of the loan). So- called ‘covenant - lite’ loans (loans that come with less restrictive debt covenan ts) enable firms to take on more debt without maintaining financial performance and currently account for 85% of the leveraged loans that are in the American market today. 23 This is vastly different to the 23 percent of loans in 2011 being ‘cov - lite’, mean ing that investors are less protected and therefore exposed to default if credit quality is poor and market conditions weaken the performance of the borrower.

14 The Economist , ‘America’s corporate debt mountain’. 15 Ibid. 16 Ibid. 17 Ibid. 18 Kenton, ‘ Leveraged Loan ’.

19 Valladares, ‘ Leveraged Finance Market ’. 20 Lee, ‘ Leverage Loans vs Junk Bonds ’.

21 Christie and Duffy, ‘ European Leveraged Finance ’. 22 Valladares, ‘ Excessive U.S. Corporate Risk Taking ’. 23 Upcounsel, ‘ Covenant Lite ’.


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