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Corporate Debt Was a Recession Time Bomb – Coronavirus Just Lit the Fuse

Corporate Debt Was a Recession Time Bomb – Coronavirus Just Lit the Fuse
  • Coronavirus has created the economic conditions that will pop the corporate debt bubble after a decade of inflating.
  • The impact will be massive because a host of businesses that have been relying on refinancing cheap loans will struggle to stay afloat.
  • The amount of low-quality corporate debt that’s been issued is unprecedented and will have far-reaching consequences as the bond market declines.

Over the past few weeks, the refrain from both lawmakers and stock market pundits has been “don’t panic.” But the dangerous cocktail of uncertainty created by the coronavirus and a showdown between oil producers has officially caused a financial market crash of epic proportions – and a recession is probably close behind.

Things are about to get worse as irresponsible borrowing among American businesses over the past few years blows up in their faces and pushes the U.S. into a recession.

Corporate Debt is Out of Control

Over the past few years, a corporate debt bubble has been quietly inflating as market conditions encouraged borrowing at low rates.

Ultra-low interest rates meant borrowing was nearly free, which prompted businesses to build up incredible debt piles. Investors largely ignored the growing dependence on cheap credit as a strong economy kept the problem from bubbling to the surface.

But the day of reckoning is here for American corporations laden down by excessive debt obligations. The U.S. economy will pay the price as it’s pushed into a recession.

As investors run from corporate bonds, irresponsible borrowing is about to blow up in the U.S. economy’s face. |Source: Yahoo Finance

The stock market’s plunge is likely just the beginning of what’s expected to be a much wider economic impact from coronavirus. Not only will consumers become skittish in the weeks ahead, but supply chain disruptions and instability in oil prices will weigh heavily on just about every industry.

For those companies carrying around an insurmountable debt pile, it’s going to be difficult to stay above water.

Corporate Debt by the Numbers

According to a report by S&P Global Market Intelligence, $4.1 trillion worth of corporate debt will mature in 2020. Roughly a third of that figure is speculative-grade credit, meaning it will be nearly impossible in today’s market to refinance.

Of the corporate debt coming due this year, a third is deemed low-quality. |Source: S&P Global Market Intelligence

What’s more, even investment-grade debt has fallen out of favor among investors. The corporate bond market’s steep declines over the past few days have made the cost of borrowing much higher.

That means U.S. firms will be forced to cope with sagging demand by cutting costs through layoffs and closures. But that will only exacerbate the economic downturn and increase the potential for a recession.

Andrew Brenner of National Alliance Securities warned of the risks playing out in the corporate bond market, saying,

We are seeing significant liquidations, liquidity continues to be a problem and it is getting worse.

Morgan Stanley’s Ruchi Sharma estimates that one in six U.S. companies doesn’t have the cash flow to cover its own interest payments. Such firms have been relying on the debt market to continuously refinance.

But those days are over.

This Is a Global Crisis

The U.S. isn’t the only place irresponsible borrowing has gotten out of control either.

According to a report by Serdar Çelik and Mats Isaksson for the Organization for Economic Cooperation and Development, the past decade’s worth of borrowing has created an unprecedented amount of low-quality corporate debt.

The breakdown of corporate debt quality suggests a day of reckoning is coming. |Source: OECD

The OECD report found that excluding financial institutions, debt among corporations around the world rose to $13.5 trillion at the end of 2019. That’s the highest it’s ever been. Compared with previous years, the data show that outstanding corporate bonds not only have lower quality ratings, but they also have inferior investor protection.

Over the past decade, 20% or more of corporate bonds issued have been non-investment grade. Issuing such a high proportion of non-investment grade bonds over such a long period hasn’t been seen since the 1980s. It suggests default rates will be inflated in an economic downturn. That will increase the chances of a long-term recession.

The quality of corporate debt has deteriorated substantially over the past few years. |Source: OECD

BBB bonds, which are the lowest quality of investment-grade bonds, made up more than half of the investment-grade bonds issued in 2019. Only 30% of non-financial corporate bonds came from companies based in advanced markets and rated A or above.

The bottom line? There’s a huge corporate debt pile out there, and most of it is of dangerous, poor quality.

Recession Likely as Businesses Shutter

Some argue that the stability of today’s banks means another financial crisis isn’t likely. But at the very least, we’re about to see a series of defaults and bankruptcies as the beneficiaries of the easy-money era are forced to confront their viability in today’s market.

As Alberto Gallo of Algebris Investments in London put it,

There are whole sectors that survived [over the past decade] that should have gone into restructuring. Retailers in a world of online retail, energy companies with high production costs, small banks in Europe that are not efficient. The availability of funding at very cheap rates has kept zombie companies alive. This means we have an accumulated level of fragility in the economy which can be exposed very easily to real shocks.

Disclaimer: This article represents the author’s opinion and should not be considered investment or trading advice from CCN.com.

This article was edited by Josiah Wilmoth.

Last modified: March 13, 2020 5:59 PM UTC

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