A Look at Corporate Leverage

Companies in developed markets have been criticized in the past for taking on too much leverage. While it is true that the net debt to EBITDA ratios have increased and as well as the share of companies earning sub-investment grades from credit-rating agencies. Yet credit rating downgrades have not been significantly widespread; much of the change can be attributed to a shift in newly rated corporate debt. Analysis on debt shows that most of the now low-rated corporate debt either did not have a rating in 2008 or didn’t exist. Therefore, the increase of sub-investment grade bonds has an element of new companies tapping into debt markets to take advantage of an economic growth as well as a favorable interest rate environment.

The economic growth and interest rate environment since the 2008 crisis allowed companies to increase their debt levels. US corporate debt increased from $2.3 trillion at the time to $5.2 trillion in 2018. While sounding alarming, the actualities are more nuanced. The increase in sub-investment-grade companies is more attributable to newly rated corporate debt, rather than from downgrades of existing companies.

Looking forward to a possibly increasing interest rate environment, the dangers of rising rates are limited. It is estimated that over 75% of corporate debt is in the form of corporate bonds, and thereby mostly fixed-rate. Fixed rate investments are generally not affected by interest-rate changes (that is until refinancing is needed), and thus estimates suggest that less than 35% of corporate bonds are adversely affected by interest rate hikes until 2022.

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