Coronavirus Exposes The Danger of Corporate America’s Debt Binge

Coronavirus Exposes The Danger of Corporate America’s Debt Binge

A slowdown in consumer and business spending could send heavily
leveraged companies into default.

By Rich Miller
Bloomberg.com
March 11, 2020

The coronavirus is threatening to expose the Achilles heel of the
U.S. economy: heavily leveraged companies.

As the economic expansion stretched into a record 11th year and
interest rates stayed at ultralow levels, business debt ballooned
and now exceeds that of households for the first time since 1991.

What’s more, the borrowing has increasingly been concentrated in
riskier companies with fewer financial resources to ride out virus-
riven difficulties.

A wave of defaults would intensify the economic impact of the
contagion.

“It will add to recessionary pressures in the U.S.,” says Nariman
Behravesh, chief economist at consultant IHS Markit Ltd.

Energy companies are especially vulnerable, thanks to a collapse
in oil prices.

But they’re not alone.

Debt tied to travel companies such as American Airlines Group
Inc. and Hertz Global Holdings Inc. has been hit hard, as have
the obligations of Movie Theaters and Casinos.

Federal Reserve Chairman Jerome Powell has dismissed
comparisons of the business borrowing binge to the pre-crisis
housing debt bubble, arguing that the financial system is now
better able to handle credit losses.

But he has acknowledged that some debt-laden businesses could
face severe strains if the economy deteriorates and that they could
amplify any downturn by laying off workers and cutting back on
investment.

The Fed is trying to cushion the economy—and the corporate
sector—from the blow of the coronavirus by lowering borrowing
costs and pumping money into the financial system.

Last week the central bank executed an emergency interest-rate
cut amid plunging financial markets.

Behravesh says Congress and the White House will also have to act.

“We’re going to need them to set up a bailout fund, then decide
where to distribute it,” he says.

President Donald Trump told reporters on Monday he will seek a
payroll tax cut and “very substantial relief” for industries that have
been hit by the virus, reversing course on the need for economic
stimulus hours after stock markets posted their worst losses in more
than a decade.

There are about $1.3 trillion of high-yield bonds outstanding,
up from $786 billion a decade ago.

The investment-grade credit market has more than doubled
to $6 trillion in the same period.

Almost half the investment-grade bond market is now rated BBB,
which means it could be downgraded to junk levels if the economy
falters.

Should that happen, many investors would need to sell the debt
to comply with restrictions on the quality of their holdings.

In the $1.15 trillion leveraged loan market—where companies
already carrying a lot of debt get more—borrowers have used
adjustments to their earnings to reduce their apparent level
of indebtedness.

A downturn could expose their weakness.

Analysts at Barclays Plc estimate that buyers of U.S. leveraged
loans will be able to recover only 55 to 60 cents on the dollar,
compared with 67 cents historically, because of companies’
dubious earnings math and rising debt loads.

With broad financing markets shut for now, desperate companies
are turning their attention to the $812 billion private credit market.

In times of stress, these lenders—private equity firms and
others—often step in to provide financing to borrowers that
would otherwise go without, at a cost.

But that might not be a cure-all.

A slowdown in consumer and business spending could
be particularly damaging for broadly syndicated loans
and private credit, much of which is debt rated B and
below, according to UBS credit strategist Matthew Mish.

That debt is among the riskiest in the high-yield market because
downgrades can put it in CCC, the lowest tier.

“Companies with vulnerable balance sheets—meaning little cash,
high maturing debt—are going to have difficulty refunding
themselves,” Mohamed El-Erian, chief economic adviser at
Allianz SE, told Bloomberg Radio on March 9. “There is going to
be an increase in credit defaults.”

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irus-exposes-the-danger-of-corporate-america-s-debt-binge?srnd=
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