Corporate debt is rising, but it’s safer than it looks

(CNN)As US corporate debt continues to rise rapidly, numerous investors, analysts and policymakers fear that it will either help trigger or deepen the next recession. We think those fears are overblown.

Corporate debt has grown by 60% since 2011 and has recently risen to an all-time high as a share of GDP, rising US corporate debt loads are now the number one source of fear about the next recession based on our conversations with clients. But we believe that corporate debt is not too high for four reasons.
First, corporate leverage is lower than many analysts believe. Despite the record level relative to GDP, the debt of non-financial corporations — which includes both public and private firms, but excludes financial institutions like banks — is within the range of the past 20 years as a share of cash flow and below the peak hit in 2001 (when the dot-com crash occurred). And corporate debt has actually trended lower relative to corporate assets since the mid-90s.The lower debt-to-cash flow and debt-to-assets measures are more meaningful than debt-to-GDP, as they better capture the risks of bankruptcy and illiquidity.
Second, the amount of corporate debt a company can sustain is now likely higher than during most of the post-World War II period. Lower interest rates, a less volatile economy and more stable cash flows have reduced the cost of debt. That, in turn, has incentivized firms to raise leverage, allowing them to fund capital spending, hiring and acquisitions. Most importantly, the large decline in interest rates since the ’80s has allowed firms to simultaneously boost corporate debt but lower interest payments as a share of corporate cash flows.

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    Third, the structure of corporate debt has become safer, with corporations relying far less on short-term debt obligations, such as commercial paper, bank loans and advances, and refinancing risk has declined. The share of corporate debt that is short-term has fallen from nearly 50% in the early ’80s to around 30% today. This shift away from short-term funding makes businesses less vulnerable to refinancing after a sudden reduction in profits or credit availability. More stable interest rates and therefore more stable total corporate funding costs have further made businesses less vulnerable to refinancing.
    Fourth, the US corporate sector runs a financial surplus, which means that its income exceeds its spending. Looking across a big dataset of developed economies, we find that the private sector’s financial balance—that’s the total savings minus total investments of all businesses and households—is a better predictor of financial crises than debt growth. The good news is that the US corporate financial balance is positive at 1% of GDP and remains above its historic average, an unusually healthy position this deep into a business cycle expansion. The positive financial balance implies that capital expenditure is more self-financed and less dependent on external funds. Corporate investment is therefore less vulnerable to a decline in profits or a rise in interest rates than in previous cycles.
        To be sure, if the economy entered a recession, defaults would rise, corporate credit spreads would widen, and capital spending would decline substantially. After all, the corporate sector is highly cyclical. But our research finds that these risks aren’t any larger than they were in previous cycles and it’s unlikely that high corporate debt will trigger a recession or make it an unusually deep one.

        Original Article : HERE ; This post was curated & posted using : RealSpecific

         


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