Rating Agencies Caution on Corporate Debt After US Borrowing Frenzy: FT

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A boom in US corporate borrowing has laid the foundation for a wave of defaults at financially risky companies, according to leading debt rating agencies that assess and rank bonds and loans.

Sales of low-rated, “speculative-grade” debt have already reached $650bn this year, according to S&P Global Ratings, putting them on track to surpass all-time borrowing records with more than four months left to go in 2021. Companies of all types had already borrowed record amounts of cash in 2020 in an effort to ride out the coronavirus downturn.

Senior analysts at both Moody’s and S&P said furious demand from investors on the hunt for higher-yielding assets at a time of low interest rates had given less creditworthy companies access to financing with loose lending terms.

While they expect debt defaults and bankruptcies to remain low for the foreseeable future, the analysts said the current easy access to corporate financing might be laying the foundation for a future debt crisis.

“It might not come home to roost in the next year or even longer,” said Gregg Lemos-Stein, chief analytical officer for corporate ratings at S&P. “But there are clear signs of risk-taking and a lot of lower-rated issuance. We think this will lead to elevated levels of defaults down the road.”

The warnings stand in contrast to the current bullish mood in corporate credit markets, with the US economy mostly shrugging off the threat of the highly contagious Delta coronavirus variant and even highly indebted companies being able to pay lenders back from their increasing profits.

Following a severe sell-off at the start of the pandemic in March 2020, the Federal Reserve stepped in to backstop corporate bond markets. The US central bank’s actions assuaged investors’ concerns and opened the floodgates to an unprecedented wave of corporate fundraising that has yet to abate.

“It averted a much worse downturn for corporates but the trade-off is that it leads to an increase in risk and the possible creation of asset bubbles,” said Lemos-Stein.

Companies on the brink of collapse found financing to survive. Slowly, investor demand for riskier debt brought borrowing costs down. The added confidence in an economic recovery provided by the announcement of successful vaccines in November spurred further lending as investors bet on companies’ fortunes turning round.

Christina Padgett, head of leveraged finance research and analytics at Moody’s, said the hopes for recovery leave debt markets open to disappointment.

Furthermore, the potential for sustained higher inflation to push up interest rates makes companies with floating-rate debt vulnerable to a jump in borrowing costs, a threat also potentially faced by issuers with fixed-rate debt due to be refinanced.

“If you take a forward view, there are many more companies that are fragile,” she said. “They have layered on a lot of debt. What if growth slows beyond what was anticipated when that balance sheet was structured? What if real rates rise or inflation remains higher for longer than we think?

“What may be manageable given today’s outlook could be unsustainable in a higher-cost or lower-growth environment,” Padgett said.