Corporate debt collapse fears may come true this time
Wall Street’s bears are once again starting to growl about boatloads of corporate debt that spell real trouble for its investors—that is, virtually everyone with a brokerage account or 401(k).
About this time in every economic cycle, a handful of financial commentators begin to argue that all the debt U.S. companies incurred in the good times is going to come due all at once.
And that, the theory goes, will force weak companies to default and strong companies to struggle with much larger debt payments.
The massive amount of debt that needs to be refinanced is referred to as the “wall of maturities.” And as the chart below shows, it does look something like a wall.
So far, the wall of maturities has turned out to be nothing but a spooky story. Or, an opportunity for a bored analyst to torture a mixed metaphor, as when S&P’s team referred to a “ballooning maturity wall.”
In fact, since the end of the Great Recession, Corporate America has loaded up on so much cheap debt that bankers have repeatedly warned that the bond markets would implode once that debt came due.
Not a single one of those calls panned out.
Now doomsayers are sounding the alarm over the unprecedented amounts of riskier bonds (aka junk bonds) issued left and right during Covid, which will come due in the next three or four years.
So, should average investors turn off CNBC, delete Robinhood, and get on with their lives?
The only problem with that is this time the "wall of maturity bears"—much like a stopped clock is correct twice a day—might be right, but for different reasons.
The usual solution: banks just extend the term of the debts
So why hasn’t the nightmare scenario—where an unscalable wall of maturities causes a mass of defaults— happened? Mainly because Wall Street banks and bond investors didn’t want it to.
Bankers like to say, “A rolling loan gathers no loss.” That reflects their aversion to taking losses on defaulting loans and bonds. Not only does it eat into their earnings, but they often get stuck owning parts of businesses they don’t want.
Banks might be good at making loans, but they are usually lousy at running businesses. So, they roll loans over or extend their terms.
Instead of demanding repayment, they offer companies in jeopardy of default a so-called loan modification. This extends the term of the loan, often from the usual five years to seven or eight.
In return, the bank gets a higher interest rate and, in some cases, tighter terms like more restrictions on a company’s ability to borrow.
Wall Street skeptics call this, “extend and pretend.” The bank extends the term of the loan and pretends the borrower will somehow be able to pay it off later.
But in a lot of cases, pushing the wall of maturities out a couple of years allows the markets to digest these refinancings in a more orderly manner. It might also allow enough time for interest rates to come down.
A bit of a stretch?
One recent airing of these wall worries came from Salman Ahmed, the global head of macro and strategic asset allocation at Fidelity International, who spun the theory for Bloomberg.
Ahmed expects corporate defaults and economic pressures from higher interest rates to cause a recession next year. Ahmed said, “A company which financed itself at 2, 3, 4% is going to be financing at 10, 11, 12% now. That’s a huge shock.”
That looks like a bit of an exaggeration.
The 10-year Treasury and the Baa spread would have to increase dramatically in the next year or two for investment-grade companies to face 11 or 12% yields.
Junk-rated debt is now averaging about 8.40%, which is almost twice what it cost companies to borrow two years ago. While comparably high, it’s not too far from what the average rate was since the end of the Great Recession.
Also, there is four times as much investment-grade debt coming due this year—about $400 billion—than junk debt. And the two do not reach the same volume—about $400 billion each—until 2027.
Because investment-grade companies are in less peril from higher rates than junk issuers, that’s good news for lenders, borrowers, and the economy overall. No one likes to see defaults.
Even the total amount of debt coming due in the next few years is less than typical.
Goldman Sachs noted in a recent report that the total amount of corporate debt coming due in the next two years is historically low, at about 16% of outstanding bonds, versus 26% in 2007.
That, and the fact that many companies have a lot of cash on their balance sheets, could help them weather the storm until rates begin to come down.
Companies and their investors are not out of the woods yet
Because interest rates have gone up measurably, the added cost of newly issued debt will hurt companies, their employees, and their investors.
According to the Goldman report, the increased interest expense will have a significant impact on corporate borrowers’ ability to invest and raise wages.
For each dollar more of interest expense, the Goldman report estimates that borrowers must lower their capital expenditures—the money they use to build and run their businesses—by 10 cents and their labor costs by 20 cents.
With the economy still battling inflation, anything that cuts a company’s ability to make productive investments is painful.
For workers hoping their wages will keep up with the rising cost of living, seeing them cut instead is bad news indeed.
Until rates come back down, and all the debt is successfully paid off or refinanced, the combination of the two could make it a rough few years even for shareholders in those companies.
It could be that this time, the bears are right, and the wall of maturities will turn out to be more painful than in the past.