November 16, 2018

Breakingviews: GE may be canary in credit market’s coal mine

by Breakingviews.

General Electric may be the canary in the credit market’s coal mine. The company’s bonds tanked this week even as an asset sale briefly lifted its shares. That’s a warning shot for all debt investors. U.S. companies owe more money than ever, and the quality of their loans and bonds has deteriorated. Rising interest rates and slowing growth could make this a big problem.

The ailing $75 billion conglomerate is an extreme case, but it exemplifies much of what has happened in corporate America and around the world over the past decade. Historically low interest rates fueled a massive borrowing boom, enabling healthy companies to expand operations or buy back shares, and zombies to keep staggering along.

U.S. non-financial corporate debt stands at a record of more than 73 percent of gross domestic product, according to the Bank for International Settlements. It never exceeded 65 percent before the 2008 financial crisis. France’s corporate debt-to-GDP ratio has risen by nearly a third over the past decade, and China’s by more than two-thirds.

This growing quantity has been accompanied by a marked decline in quality. GE, which recently lost its coveted single-A credit rating, is again illustrative. Many other U.S. companies have been downgraded. As a result, the debt of those carrying triple-B ratings – the lowest investment-grade category – more than doubled from pre-crisis days to a record $2.7 trillion at the end of 2017, according to S&P Global Ratings.

At the same time the U.S. junk-bond market has swelled to more than $1.2 trillion and leveraged loans now total $1.3 trillion, much of it so-called covenant-lite products with few investor protections. That prompted Senator Elizabeth Warren on Thursday to warn that leveraged lending “exhibits many of the characteristics” of the subprime mortgage boom that triggered the 2008 financial crisis.

Up to now, many investors have shrugged off such risks, comforted by surging corporate earnings – up nearly 29 percent for the S&P 500 Index in the third quarter. But earnings growth is expected to drop into single digits next year, according to Refinitiv estimates. Meanwhile the expected rate hike by the Federal Reserve next month will ratchet up the cost of borrowing. The numbers don’t add up to a crisis yet, but the trend is heading in that direction.

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