Non-financial companies borrowed US$2.1 trillion through corporate bonds last year, pushing the volume of corporate debt to a record high of $13.5 trillion.
In the past three years, more than half of all new investment-grade bonds (52%) were rated BBB, the lowest investment-grade rating, just one notch above junk status. Before the last financial crisis, from 2000 to 2007, the share of investment-grade bonds averaged 39%, the Organisation for Economic Cooperation and Development reported.
The Paris-based organisation is concerned that the average credit quality is lower, while payback requirements are higher, maturities longer and investors generally less protected. Longer maturities mean greater price sensitivity to interest-rate changes, especially in connection with lower credit quality.
OECD research shows the median firm in each investment-grade rating has higher leverage ratios compared to a decade ago. At the same time, influenced by unprecedented low interest rates since 2008, their ability to cover their current interest obligations has improved. This is because low interest rates since 2008 have enhanced the ability of companies to cover their interest obligations.
But if interest rates start to increase or an economic downturn leads to lower earnings, interest coverage and profitability ratios could deteriorate rapidly, limiting companies’ abilities to offset the high leverage, the OECD said, in a report on bond trends. A recession would trigger downgrades of many of the investments and exacerbate the negative economic effects for non-financial companies. The OECD believes about $261 billion of BBB-rated bonds could no longer be classed investment grade, if the economy turns.
The share of non-investment grade bonds has also grown in the past decade, when at least 20% of bonds issued have been lower than investment grade. In 2019, a quarter of all new non-financial corporate issues were junk bonds. At the same time, only 30% of the global outstanding stock of non-financial corporate bonds were rated A or higher and issued by companies from advanced economies.
The OECD noted, “This is the longest period since 1980 when the portion of non-investment grade issuance has remained this high and indicates that default rates in a future downturn will likely be higher than in previous credit cycles.”
The high outstanding stock of corporate bonds has led to increasing repayment obligations. At the end of 2019, non-financial companies worldwide had to repay or refinance an unprecedented $4.4 trillion worth of corporate bond debt within three years. This represents a record 32.4% of the total outstanding amount of corporate bonds, up from about 25% 10 years ago.
“Structural reforms and monetary policy have promoted the use of corporate bond markets as a viable source of long-term funding for non-financial companies since the global financial crisis,” said OECD Secretary-General Angel Gurría. “The high levels of leverage in the corporate sector now make it essential to put in place reforms that make all parts of capital markets fit for purpose. This must include steps to improve the ability of equity markets to strengthen corporate balance sheets and support long-term investments.”