- Overleveraged companies could be the cause of the next financial crisis, given their high levels of debt.
- Major US corporations have been taking advantage of low interest rates and favorable quantitative-easing conditions to pile on debt and acquisitions.
- US companies have $4.4 trillion in rated debt maturing through 2022, before more expensive refinancings take hold.
The major surge in debt issuance by US corporations through highly levered buyouts and low-interest-rate acquisitions could be a major part of the next financial crisis, according to the research firm CLSA.
Excess leverage suggests that markets could be set for a “Minsky Moment,” or a sudden and major collapse in asset valuations. The theory goes that stability begets instability, namely that investors take more risks when things appear to be safe and steady, thus sowing the seeds of their own demise.
As such, rising leverage can be seen as a conduit to greater financial market instability.
If you’re looking for a culprit, CLSA says, look no further than the Federal Reserve. The central bank’s quantitative-easing practices have caused the natural relationship between corporate-debt expansion and default rates to break down. As a result, US debt is at an all-time high of $14 trillion (45% of gross domestic product) and high-yield default rates are near all-time lows at 3.3%.
Shaky leveraged loans
Based on recent behavior, it appears that investors are already starting to question their exposure to the leveraged-loan market. About $13 billion flowed out of funds tracking the space during the last six weeks of 2018. These outflows are significant because leveraged-loan bundles look like one of the shakiest investment vehicles right now. Leveraged-loan volume remains at approximately $1.6 trillion globally, however.
Intriguingly, it’s companies like AT&T and GE that have some of the highest debt piles in the US. And while many of them are now seeking to reduce their debt piles, their inability to do so could negatively affect the broader market, particularly if such a company’s debt is junked.
Companies have been bloated by cheap debt in the years following the financial crisis as the availability of “covenant-lite” loans became more commonplace in the market. Leveraged lending has been criticized by many major figures in the financial world including Janet Yellen, the Bank of England, and the Federal Reserve.
Similarly, where leverage was previously seen as a stumbling block in negotiations, it now appears to be commonplace in the US debt markets. The US government’s Leveraged Lending Guidelines, from 2013, capped leverage at six times to avoid excessive risk-taking, but it’s now a regular occurrence to see leveraged buyouts at higher leverage levels.
For example, KKR’s $5.5 billion buyout of Envision Healthcare through a debt financing was one of the largest deals in 2018 and was up to seven times levered. Similarly, a $13.5 billion deal by Blackstone to purchase a 55% stake in Thompson Reuters’ financial-data service, now known as Refinitiv, was the largest LBO since the financial crisis.
AT&T and GE
Take AT&T, which committed to pay down $18 billion to $20 billion of its outstanding debt of a staggering $183 billion (as of September), more than some countries’ gross domestic product. The company’s big-money ($82 billion) purchase of Time Warner was the source of much of the debt, as was AT&T’s $49 billion acquisition of DirecTV in 2015. The telecoms giant is now the most levered nonfinancial company in the world and will have to consider its capital structure in light of its large debt pile.
AT&T shares dropped about 27% in 2018, and Moody’s downgraded the company’s credit rating in June, citing its “excess leverage,” leaving the company with a rating just two notches above junk.
GE’s debt pile has also been a cause of concern for investors. The company has about $115 billion in debt between GE and GE Capital, much of it rated BBB+, the lowest investment grade available.
For context, nearly 13% of LBOs in the first nine months of 2018 were financed with debt equating to at least seven times the target company’s earnings before interest, taxes, depreciation and amortization— or Ebitda — according to S&P Global Market Intelligence’s LCD.
To some experts, this is waving a big red flag.
“There may be material loosening of terms and weaknesses in risk management of the leveraged-loan market,” Todd Vermilyea, a senior associate director in the Fed’s regulatory division, told the Loan Syndications and Trading Association in New York last October.
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