Cheap debt is a narcotic. Back in 2018, many corporates tried to quit. But as central banks turned on the taps again in 2019, businesses once again succumbed. Last year, they borrowed an additional $2.1tn in the form of corporate bonds, says the Paris-based OECD.
The scale of the decade-long bond binge is unprecedented. So too is the poor quality of much of the debt. Over half of investment grade bonds — 51 per cent — was rated triple B, the lowest tier, last year. During 2000-2007, the portion was 39 per cent.
Triple B is just one notch above junk status. The danger is that a recession causes downgrades. Many holders would then have to sell the bonds of such “fallen angels” as their mandates stop them owning non-investment grade paper.
Take US food company Kraft Heinz, for example. Last week, rating agencies cut its rating below the investment grade threshold, making it the largest “fallen angel” in almost 15 years, according to data from Ice Data Services. Kraft’s bond due in 2046, formerly trading above 102 cents on the dollar, has slumped to 93 cents.
Expect more dropouts from the heavenly host. The OECD reckons $261bn of triple B rated bonds would fall off the lowest rungs of the investment grade ladder in a serious economic downturn.
Higher borrowing costs are not the only threat to companies. Investors are also taking bigger risks. They may be over optimistic that they can easily sell their holdings in a relatively illiquid market. That fear has increased with the growing portion of triple B bonds in the portfolios of US investment-grade corporate bond mutual funds — up sharply from 20 per cent to 45 per cent in the eight years to 2018.
For now, bondholders seem unfazed. Central banks are supportive on liquidity. Interest cover, operating profit as a multiple of interest payments, is relatively high historically, says UBS. Many companies may aim to reduce their debt levels. But policy wonks are right to worry. The longer the debt binge continues unchecked, the harder it will be to kick the habit later.
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