From David Dutkewych: Years of cheap credit have not only helped the U.S. economy recover, but the world’s economy. There’s no doubt about it.
But at what cost? Financial stability, at least according to the International Monetary Fund’s (IMF) latest assessment. They’re warning that ballooning U.S. corporate debts are getting way, way out of control.
In fact, U.S. companies have added a whopping $7.8 trillion of debt and other liabilities since 2010.
You read that right: $7.8 trillion with a “T.”
And in just seven years!
Debt is piling up so fast that it’s nearing the bloated debt levels not seen since the 2008 financial crisis.
High corporate debt levels are not inherently a problem. But when that kind of cash is added at super-low interest rates – unsustainable super-low interest rates – then things get nasty rather quickly for corporate balance sheets when interest rates tick higher.
That’s why I’m not one bit surprised that since the Federal Reserve began normalizing rates, corporate credit fundamentals have weakened big time. And that’s created the conditions that historically precede a credit-cycle downturn, according to the IMF’s report.
Take the average interest-coverage ratio for example. It measures a company’s ability to meet its interest payments. When times are good – and credit is cheap – you’d expect that ratio to improve.
The scary thing is the opposite is happening …
As you can see in the IMF chart above, the average interest-coverage ratio has fallen sharply over the past two years: Earnings are now covering less than six-times the cost of interest. That’s way off its highs and closer to the weakest multiple since the onset of the financial crisis. Yikes!
But it gets worse.
I don’t have to tell you that firms have chosen to buy their own stock rather than issuing/floating fresh shares. And they’re going on these buying sprees by going deeper in debt to buy back the stock. Stock that is, given the run-up in the markets, already at nosebleed levels.
In addition, corporate credit quality has been hammered by weakening debt covenants and by a rise in rating downgrades.
So, it’s no wonder that corporate leverage ratios – read: debt loads – have been on the rise since 2010 and have now come close to historical peaks. Take a look at this IMF chart …
Bottom Line: U.S. companies are piling on the debt, and their leverage metrics are the worst I’ve seen in years. The IMF says the spending sprees are grinding away at financial stability. We know there is a mountain of debt out there and that U.S. corporate debt is creeping toward levels last seen in 2007.
We also know that there are sectors vulnerable to higher interest rates and to rising borrowing costs. So, don’t just sit back and relax! Beware of sectors that are bloated with debt, including energy, utility, and real estate.
The Energy Select Sector SPDR ETF (NYSE:XLE) rose $0.05 (+0.07%) in premarket trading Friday. Year-to-date, XLE has declined -10.00%, versus a 6.74% rise in the benchmark S&P 500 index during the same period.
This article is brought to you courtesy of Money And Markets.