Stock markets are growing confident the worst of the pandemic is behind us. The debt market, though, will need more convincing.
In a report this week, the Institute for International Finance estimated that global debt now tops US$255-trillion. That works out to a staggering US$87-trillion more than at the onset of the financial crisis in 2008.
Yet the enormous borrowing binge that has taken place over the past 12 years shows no signs of slowing down. Just the opposite, in fact. The world’s mountain of outstanding debt is set to soar this year as nations and businesses alike raise money to help offset the damage from the novel coronavirus.
The IIF figures the onslaught of new borrowing this year will propel the global debt burden to more than 342 per cent of the world’s economic output, a mighty jump from the 322-per-cent level at the end of 2019.
What is not clear is how the bond market – especially the market for corporate debt - will react to this galloping demand for cash. The tug of war between nervous lenders and money-hungry borrowers could send borrowing costs for many companies spiralling higher.
Rising interest rates would be bad news for businesses that have piled on debt willy-nilly over the past decade, but are now being downgraded by credit raters over virus-related concerns. In a worst case, these borrowers will be confronted with higher borrowing costs at the same time as lockdowns due to the pandemic eat away at their sales and profits.
Signs of stress are already evident. Consider the striking number of well-known companies that have lost their investment-grade ratings on their bonds in recent weeks, a sign that lenders no longer regard them as sure things. The biggest of these “fallen angels” is Ford Motor Co., while other examples include Occidental Petroleum Corp., Kraft Heinz Co. and Macy’s Inc.
The bonds of these big-name U.S.-based companies are now high yield, or “junk”, in bond market jargon, meaning they must pay significantly more to borrow than investment-grade businesses.
Many Canadian companies should be concerned that they too may soon face higher borrowing costs. This country’s businesses are among the most highly leveraged borrowers in the world, according to a recent analysis by Aswath Damodaran of New York University.
High debt levels do not bode well at a time when lenders are pulling back from anything that smacks of danger. Two deals concluded this month demonstrate that lenders are demanding punishing payoffs from companies they regard as at risk.
In the first case, Airbnb Inc. arranged to raise US$1-billion in new financing from a couple of private investment firms. The home-sharing service, which is reeling from the collapse of tourism, is paying an interest rate of 10 per cent, according to the Wall Street Journal.
In the other example, Carnival Corp., the world’s largest cruise operator, borrowed US$4-billion from a group of investors. Carnival, which has also been hammered by the tourism shutdown, is paying close to 12-per-cent interest.
Many companies would go out of business if they had to pay anywhere close to such rates. To help forestall that possibility, the U.S. Federal Reserve took dramatic action on Thursday.
It announced it would buy up a broad swathe of riskier bonds, including many of the newly fallen angels. By acting as a buyer of last resort for these corporate bonds, the Fed will help push up prices and push down interest rates.
But whether the new program will be enough to restore order to debt markets will depend on how severely the pandemic punishes corporate revenues. As things now stand, Bank of America warns that as much as US$200-billion in investment-grade debt could be downgraded to junk status this year.
The new program also raises concerns about whether the central bank is, in effect, bailing out the private equity firms that hold stakes in many junk-rated companies. In time, this could prove to be a politically explosive issue.
For now, though, the Fed and other central banks have little choice but to help out fat cats as well as everybody else. The alternative would be to risk a wave of bankruptcies and lost jobs.
The Bank for International Settlements, an international organization of central banks, has warned for years about the growing number of “zombie” firms – companies that are consistently unable to cover the cost of their debt payments from operating profits.
In a report last year the BIS estimated that somewhere around 6 per cent of all non-financial companies listed on major stock exchanges are zombies. If interest rates on corporate debt spike as a result of the world’s new borrowing binge, we will soon find out just how large the zombie horde really is.
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