Debt is again near the top of investors’ worry lists, but does it matter beyond portfolios of corporate bonds and loans?
Companies have been piling on debt in recent years, but unlike in the run-up to the 2008 financial crisis, individuals haven’t. This could be the saving grace for many economies. Household borrowing is more likely than the corporate kind to make a recession more painful.
Corporate borrowing has boomed since about 2011 and now sits at a record high of 92% of global output, according to the Institute of International Finance. In the U.S., it is a record 46.5%.
However, companies and people can live with high levels of debt if interest costs are low or incomes are growing, for example. What matters more is how quickly more debt is taken on, as Ben Broadbent, deputy governor of the Bank of England and a former Goldman Sachs economist, noted in a speech last week.
Rapid growth in debt often means looser lending standards. Protections for lenders decline, debt issuance comes more from riskier borrowers and yet the cost of credit tends to fall, Mr. Broadbent said.
This is what the U.S. and Europe have witnessed in recent years, especially in leveraged loans, the junk-rated debt used mainly by private-equity backed companies to fund deals or dividends. Such loans used to be a small element of debt markets: In the U.S., they were only about 2% of all corporate debt back in the early 2000s. Now they are more than 11%, driven partly by large deals such as Blackstone’s (BX) buyout of Thomson Reuters’ information business, Refinitiv.
Policy makers worry when credit growth outstrips economic growth and this has certainly been happening with companies. In the U.S. since the start of 2011, growth in nonfinancial corporate credit outstanding has averaged an annualized rate of 6% per quarter, which beats average nominal GDP growth of 3.9% on the same basis, according to Haver Analytics and Federal Reserve data.
Growth in U.S. leveraged loans in the benchmark LSTA index, meanwhile, has averaged more than 10% per quarter annualized, according to S&P Global Market Intelligence LCD.
Bank of England researchers have found in recent studies that corporate credit growth matters more for recessions than economists previously thought. However, household debt is likely more important. Mortgages, student loans and credit cards affect consumers’ spending power and financial health much more directly than company borrowing, and particularly a niche market like leveraged loans.
The good news is that growth in household debt has been subdued: In the U.S. it has risen just 1.6% per quarter annualized since 2011. So while the outlook for indebted companies is rocky, the prospects for the wider U.S. economy—as determined by debt at least—may not be so bad.
The rapid growth of risky corporate debt is definitely something for lenders to worry about, but on its own it shouldn’t cause another 2008-style meltdown.
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