by Mario Lettieri and Paolo Raimondi * –
There is not only public debt to keep under control. “Corporate debt”, the debt of private companies, could represent a greater danger. On the other hand, governments support and guarantee sovereign debt, while corporate debt is totally dependent on the market and investors.
The problem is highlighted by the recent study “Global debt report 2024: global markets in high-debt environment” by the Organization for Economic Co-operation and Development (OECD). Over the last 15 years, global corporate debt has risen from 13,000 to 34,000 billion dollars. 60% of the total is from non-financial companies which on average have more than doubled their annual bond issuance.
Since 2008 the increase has been very strong: more than 72% in the USA and 51% in Europe. But the exceptional growth occurred in China, where corporate debt rose from 1% to 20% of the global amount from 2008 to 2023. In recent years, the Chinese real estate sector, and also those of other countries, has made great use of corporate bonds. The difference is that in China private businesses are, in fact, controlled and supported by the state.
The extraordinary global increase was favored by central banks’ accommodative quantitative easing policies with the creation of enormous quantities of liquidity and zero interest rates. Central banks have also bought many corporate bonds, inflating their balance sheets which they now have to streamline.
This also favored the extension of the duration of the bonds which on average went from 5.6 years in 2000 to 7.9 years in 2023. Furthermore, the majority of the bonds were issued with fixed interests, thus guaranteeing a certain protection from any fluctuations.
In the last period everything has changed and the risk has grown exponentially. First of all, the increase in the interest rate will make the future of corporate bonds uncertain and dangerous. Globally, by 2026 private bonds worth 12,300 billion will reach maturity and will have to be renegotiated. Obviously they will mostly be at a variable rate, making them subject to future fluctuations.
The share of bonds that are just above the so-called non-investment grade threshold, below which they are considered junk, has grown enormously. Rating agencies consider the BBB rating to be the minimum threshold. In 2023, BBB bonds represented 53% of the total. The vast majority are from American companies.
Additionally, 42% of BBB-rated bonds were issued by companies with a debt-to-EBITDA ratio greater than 4. This is an indicator of a company’s profitability, excluding taxes, depreciation, amortization and interest. The ratio indicates the number of years needed for the cash flows to be able to repay the debt. It should be kept below threshold 3; level 4 indicates a high risk situation.
Also keep in mind that many institutional investors, such as insurance companies and pension funds, are obliged by law and their internal regulations to only hold securities with a highly positive rating on their balance sheets. Which will make it difficult to refinance many securities.
Over the years there has also been a significant diversification of credit intermediation which has moved from the traditional banking sector towards investment funds and in particular exchange-traded funds (ETFs) listed on the stock exchange, whose risk capital is made up of actions of the participants. ETFs are often speculative and operate using financial leverage, i.e. on a multiple of the capital actually available. Since 2000, the participation of various investment funds has grown dramatically, so much so that for many of them corporate bonds represent 75% of the portfolio. As of early 2024, the entire fund sector held the equivalent of nearly $9 trillion in corporate bonds.
Among the 4 most indebted companies, three are American. In the lead there are two that enjoy government sponsorship, the Federal National Mortgage Association, known as Fannie Mae, with 4,200 billion in bonds and the Federal Home Loan Mortgage Corp, known as Freddie Mac, with 3,200 billion in bonds. Both buy and guarantee real estate mortgages. Third place is held by Argentina’s troubled Pampa Energia, followed by JPMorgan Chase bank.
It is clear that we are faced with a mix of very fast and equally dangerous changes. The “bundle” of easy money and credit is over. Who will lead a soft return, without new serious debt crises, since the possible controllers, governments and central banks, are primarily responsible for the past go-go liquidity “bonanza”? It seems to us that the 2008 crisis taught us nothing!