When Investments Bankers agree to underwrite leverage in January The return on safe assets such as government bonds from software company Citrix, a group of private equity firms, has been troubling. Yield-hungry investors are desperate for any meaningful returns, something Citrix’s $16.5 billion exchange promises. Lenders including Bank of America, Credit Suisse and Goldman Sachs were happy to offer $15 billion to fund the deal. Central bank officials insist that inflation is temporary. Russia has not invaded Ukraine, energy markets are quiet, and the world economy is growing.
Nine months later, banks are trying to stay in a world where not greed but fear – stubborn inflation, war and recession – sell debt in the market. Struggling to find a taker, they sold $8.6 billion in debt at a discount, resulting in a $600 million loss. They are still maintaining the remaining $6.4 billion on their balance sheet.
The Citrix fiasco is a particularly egregious example of a broader shift in corporate debt markets. After rediscovering their inner Volcker, Western central banks are pushing interest rates to levels not seen in 15 years and shrinking their balance sheets. Those who bought corporate bonds during the pandemic to prevent a wave of bankruptcies have been selling or have sold. All of this is draining liquidity in the market, as investors ditch riskier assets such as corporate bonds in favor of safe Treasuries, which are suddenly poised for significant gains, said Torsten Slok of Apollo, a private asset manager. s return. The result has been a slump in corporate bond prices, especially for companies with poor credit: yields on junk bills have soared to 9.1% in the US and 7.5% in Europe from 4.4% in January and 2.8% in Europe (see Figure 1).
All of this raises some awkward questions about what happens next to the massive debt the company has accumulated in recent years (see Figure 2). Since 2000, non-financial corporate debt has risen from 64% of GDP to 81% in the US and from 73% to 110% in the euro area. (In the U.K., it was just 68 percent, roughly the level in 2000, a rare point of relief for an otherwise troubled economy.) All told, listed companies in the U.S., U.K. and euro area are now Nearly $19 trillion is owed to creditors, with private companies owed another $17 trillion. How unstable is this pile?
The credit crunch will not affect all borrowers equally. In fact, on the whole, corporate debt burdens in the West appear manageable. We calculate that US public companies’ EBIT is 6.7 times the interest due on their debt, up from 3.6 times in 2000. In the euro area, this interest coverage ratio has risen to 7 times from 4.4 this century. In addition, some riskier borrowers took on debt at low interest rates during the pandemic. By value, only 16% of the euro zone’s junk bonds are due by the end of 2024. In the US, the figure is 8%.
However, the surge will cause pressure on borrowing costs in three ways. The first includes businesses that have come to rely on less orthodox sources of credit, often among those with the worst prospects. In the U.S., the outstanding value of leveraged loans, often provided by a syndicate of bank and non-bank lenders, is now comparable to junk bonds, and has been growing rapidly in Europe as well. So is the value of private credit provided by private asset managers such as Apollo and Blackstone. Such loans tend to tolerate higher leverage in exchange for high and now more troubling floating rates. As a result, borrowers are more vulnerable to higher interest rates. Because such debt typically comes with fewer strings attached, lenders have limited ability to expedite repayments if signs of distress appear. Vulnerability involves so-called zombie companies: uncompetitive businesses that live off cheap debt and government bailouts during a pandemic. Fortunately, by our calculations, corporate undead are relatively rare and generally small. We define zombie companies as companies that are at least 10 years old and have an interest coverage ratio of less than or equal to 1 for at least 3 consecutive years, excluding fast-growing but loss-making technology companies, and unprofitable businesses in biotechnology, where products take years to develop Enter the market, as well as holding companies with less revenue. From this definition, we identified 443 active zombies listed in the US, UK, and Eurozone (see Figure 3). This is up from 155 in 2000, but represents only 5.6% of all public companies, 1.9% of total debt and 1.4% of total sales. Their demise could be a gain for the economy, as poorly managed, unproductive, bailout-heavy companies end up going out of business, though it would be a cold consolation for their employees and owners.
No. The three and biggest areas of focus involve companies that just don’t fit, not die. One way to capture its popularity is to look at companies with less than double interest coverage. That gets you one-fifth of the combined debt of US and European public companies — worth about $4 trillion (see Figure 4). Or consider companies with debt ratings just above junk. According to ratings agency Fitch, about 58% of the investment-grade non-financial corporate bond market is currently rated bbb. The average yield on such bonds in the U.S. has more than doubled over the past 12 months to 5.6%. Unlike high-yield bonds, many of which are coming to maturity and need to be refinanced at higher rates.
Since the global financial crisis, many established companies with slow sales growth have used cheap credit to build up the cliff of debt junk status in order to fund shareholder payouts. They are under pressure as profits come under pressure and interest costs rise, potentially leading them to cut jobs and investment. If some analysts start predicting a plunge in earnings as recession fears mount, this funding strategy could push these companies to the brink of junk territory. Asset managers whose portfolio mandates require them to favor safe assets could be forced to sell, triggering a price slump and an even bigger spike in borrowing costs.
Goldman Sachs’ Lotfi Karoui believes that most companies operating slightly above junk status are still a long way from being downgraded. Many of the most vulnerable investment-grade borrowers were downgraded early in the pandemic, so the rest are on average more robust. In other words, nightmarish scenarios are not inevitable. But this is no longer unthinkable. â–
