Just as governments are cutting back on issuing new debt, the corporate sector has taken up the role of being the largest source of new debt in the United States. This shift in debt issuance is readily apparent in Chart 1. Since the crisis of 2008, the growth in government debt has dramatically decreased from nearly 20 per cent annually to less than 5 per cent, more in line with the nominal growth in the economy. Consumers continue to remain wary of increasing their debt load . On the other hand, the corporate bond market has been on a bit of a tear in recent years .That segment of the debt market now outpaces all other debt issuers. The U.S. corporate bond market is valued at nearly US $9 trillion; by comparison, it is larger than the GDP of Germany, France and the U.K. combined. No longer are governments the leaders in generating new debt, it has ceded that title to corporate America.
Chart 1: Growth Rates in Debt of U.S. Non-financial Sector 2010-2015
As investors search for yield, corporate bonds are viewed as the darlings of the debt market, principally due to higher yields offered. As the demand for corporates grows, the spread in yields between corporates and U.S. Treasuries has narrowed, a further sign of the strength of the corporate bond market, thus encouraging more companies to issue debt. The rise in corporate debt is supplied mainly by investment-grade corporations i.e. from corporations with excellent credit ratings. High yielding debt (so-called junk bonds) is not as responsible for the burst in corporate debt as is often portrayed in the media . Well-heeled corporations have turned to corporate debt, rather than issuing additional equity, to meet their business needs.What lies behind the surge in new corporate debt?
Chart 2: U.S. Corporate Bonds–Annual Issuance and O/S Amounts ($mill)
Profits are inadequate to fund capital expenditures. Notwithstanding the fact that the stock market is reaching historic highs, corporate profits have steadily declined. The S&P 500 companies have experienced six straight quarters of declining profits. Table 1 connects profit growth with capital expenditures. To begin with, capital expenditures are, initially, funded from internal resources——- profits less dividends, less income taxes, plus accumulated capital cost allowances. From 2010 to 2013, U.S. non-financial corporations were able to fund business capital expenditures from internal resources. Since 2013 the sector has turned to the debt market to make up the shortfall, currently at approximately $200 billion. In and of itself, there is nothing inherently wrong with this approach, since it is vital to a company’s long-term viability to increase and improve its capital investment. Raising debt to fund business investment, rather than raising equity, is an acceptable strategy to take, especially in this low interest rate environment.
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