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BookmarkCorporations, like people, are pretty simple: They do what they are rewarded to do. So when the Federal Reserve, by keeping interest rates very low for nearly a decade, rewards companies for borrowing money by making it historically inexpensive to do so, it can’t be a surprise to anyone that that’s exactly what they did.
In 2008, in the wake of the financial crisis, the Fed began its “quantitative easing” program, a determined effort to buoy the economy by lowering the cost of borrowing. It bought up trillions of dollars in Treasury and other debt securities, effectively reducing long-term interest rates. Debt issuance exploded. In the last decade, the amount of corporate bonds outstanding nearly doubled to $9 trillion, from $5.5 trillion.
Much of that surge has come in the form of bonds rated BBB, near the riskier end of the investment-grade spectrum — meaning that the money borrowed remains at some danger, albeit low, of not being paid back. There is now nearly $2.5 trillion of United States corporate debt rated in the BBB category, close to triple the amount of 2008, making up half of the investment-grade bond market.
It’s been quite a party. Now comes the hangover.
In the last decade, well-established companies including G.E., AT&T, CVS Health, Sherwin-Williams and Campbell Soup went on acquisition binges fueled largely by cheap borrowing. As interest rates rise and the economy appears to be slowing, they are in not-insignificant danger of defaulting on the debt, a fear that has started to cause disturbing ripples in the debt and equity markets.
Exhibit A of brewing trouble is G.E. Once the world’s most valuable company and a paragon of debt virtue, it had a AAA credit rating until 2015. Those days are gone.
G.E. has $115 billion of outstanding debt, about $20 billion of which is due within a year, and it is “burning cash,” according to a recent report by a JPMorgan analyst. Its pension plan has gone from a surplus to reportedly being underfunded by some $29 billion; in October, S.&P. lowered G.E.’s credit rating to BBB, and the cost of buying insurance against a default on G.E.’s bonds, so-called credit default swaps, has soared in November. That’s a sign of investors becoming nervous that G.E. might default.
While he has been careful not to play down the company’s financial difficulties, G.E.’s new chief executive, H. Lawrence Culp Jr., pointed out this month that G.E. still has plenty of assets to sell and $39 billion available under a revolving credit line.
Then there is AT&T. With about $183 billion of debt outstanding, it is now one of the most indebted companies on the planet, thanks to its recent acquisitions of DirecTV and TimeWarner, which were paid substantially with debt. AT&T’s debt is also rated BBB, although only about $11 billion is coming due within a year. The company’s chief financial officer has said that AT&T will be able to “manage its obligations” from the cash it is generating.
But the heavy debt load leaves little margin for error, making a tricky merger — combining a legacy phone company with a major content provider — even more difficult. “I’m not even sure what AT&T is anymore,” said Christopher Whalen, the founder of Whalen Global Advisors, an advisory and economic research firm. “It’s kind of a resurrected zombie.”
Debt is very unforgiving. And yet in the last decade the debt has piled up, especially at companies that bulked up through mergers and acquisitions. Campbell Soup borrowed more than $6 billion to buy Snyder’s-Lance, the potato chip and pretzel maker, and the company’s debt is now more than five times its cash flow. After Keurig Green Mountain and the Dr Pepper Snapple Group merged, the combined company’s debt reached $17 billion, nearly six times its cash flow. Bayer now has around $40 billion of net debt outstanding after its acquisition of Monsanto; CVS Health issued $40 billion of bonds to help pay for Aetna; and Sherwin-Williams sold $6 billion of debt when it bought Valspar. By one estimate, IBM will issue around $25 billion in new debt to complete its $34 billion acquisition of the software company Red Hat.
There’s a lot at risk here. If these BBB-rated companies get downgraded further into “junk” status — a distinct possibility if a slowing economy makes a dent in their profits or if their big acquisitions do not pay off — a vicious cycle is nearly inevitable. That means higher borrowing costs when it comes time to refinance or to obtain a new credit line and an increasing risk of default.
When bellwether companies such as G.E., AT&T and IBM get into financial difficulty, that’s bad news for the rest of us. When credit markets feel nervous about the biggest corporations, it’s a good bet that it will be harder for ordinary Americans to get or refinance a mortgage, or get a car loan or credit card. It is a scenario that became very familiar a decade ago; the sequel may be upon us soon.
