Photographer: Craig Warga/Bloomberg

S&P Warns High Corporate Debt Could Trigger Next Default Cycle

The number of defaults by heavily indebted corporates could rise significantly amid tightening credit conditions, according to S&P Global Ratings.

Easy liquidity and underwriting together with low interest rates have contributed to a spike in the number of highly leveraged firms, creating a risk masked by relatively low default rates.

Removing the “easy money punch bowl” could trigger the next default cycle since high corporate debt levels have increased the sensitivity of borrowers to elevated financing costs, the ratings agency said in a Feb. 5 report.

Debt Overhang

Despite slowdown, China's leverage still represents 28% of world's total

Source: S&P Global

Based on a global sample of 13,000 entities, the agency estimates that the proportion of highly leveraged corporates -- those whose debt-to-earnings exceed 5x -- stood at 37 percent in 2017, compared to 32 percent in 2007 before the global financial crisis. Over 2011-2017, global non-financial corporate debt grew by 15 percentage points to 96 percent of GDP.

The masked discrepancy between leverage and defaults is so wide that the recent pick-up in corporate earnings and financial metrics -- especially thanks to tax reforms in the U.S. -- “won’t be enough to offset” the significant credit risks, S&P said.

“When debt is this steep and default rates are low, something’s gotta give,” wrote the firm’s Terry Chan. “A material repricing in bond markets or faster-than-expected normalization in money market rates could impact credit profiles.”

There has also been a rebalancing of credit levels in terms of sectors, according to Chan. Companies in highly leveraged industries such as infrastructure, capital goods and building materials either maintained or decreased their debt levels while those in oil and gas, metals and mining and telecommunications accumulated more leverage.

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