U.S. corporate debt levels stand above crisis highs even as default rates among the most leveraged firms remain subdued.
With an economy hitting its stride, it’s perhaps no surprise that the high-yield bond market is placid. The extent of the divergence between debt levels and defaults, however, is worrying to some analysts who feel rising corporate indebtedness will eventually catch out unwary investors and deflate the junk-bond market.
But beyond complacency John Lonski, chief economist at Moody’s Capital Market Research, argued that globalization and the tendency of U.S. businesses to hoard cash as reasons why corporate debt levels may no longer move in sync with default rates and credit spreads.
The high-yield default rate in the fourth-quarter of 2017 fell to 3.3%, even as U.S. nonfinancial-corporate debt ended in 2017 at 45.4% of GDP. This compares with a much higher default rate of 11.1% in the second quarter of 2009, with corporate debt levels at 45% of GDP. Granted, the current levels come with the economy in the eighth year of an expansion, while the second quarter of 2009 marked the final quarter of the longest and deepest U.S. recession since the Great Depression.
The yield spread between high-yield bonds JNK, +0.14% and safe government paper, as represented by the 10-year Treasury note TMUBMUSD10Y, +0.00% narrowed to an average 3.63 percentage points in the fourth quarter of 2017, from an average 12.02 percentage points in the second quarter of 2009. The tight credit spreads reflects that borrowing costs are still close to historic lows, and that investors are demanding minimum compensation for holding arguably the riskiest debt in the bond market.
One answer “might be supplied by the ever increasing globalization of U.S. businesses where the more relevant denominator is not U.S. GDP, but world GDP” said Lonski.
The fortunes of U.S. companies are now wove into the broader global economy. When commodity prices took a hit in 2015 and early 2016, crimping growth in China and other emerging markets, high-yield bonds were also slammed.
With commodity prices on the rise and global growth making a comeback, it’s no mystery that issuers of high-yield bonds aren’t in any serious trouble.
The tendency of U.S. corporations to accumulate cash could also be to blame. Lonski says net corporate debt to GDP, which subtracts total debt levels by the amount of cash in business balance sheets, was at a much more subdued 33.2%, well below the 45.2% seen in the broader debt to GDP measure.
But the meaningfulness of this statistic may be limited by the “high concentration of cash among relatively few companies,” many of which are considered highly creditworthy.
Tech companies like Apple AAPL, -0.35% and Microsoft MSFT, +0.45% have been the main components of this trend. In the past, such firms issued debt backed by the collateral of their overseas profits for share buybacks and other forms of shareholder remuneration.