- This chart looks at
investment-grade corporate debt
or debt that ratings firms
consider pretty safe.
There's a lot of it out there right now.
Over the past decade,
companies borrowed more and more
as interest rates hovered near zero.
Now, analysts are concerned.
That's because about half of that debt
or $3.7 trillion is rated Triple-B,
the lowest rating
investment-grade debt can receive.
And some are worried
this debt isn't as safe
as the ratings suggest.
Companies that make well-known products
like Campbell's Chicken
Soup and Elmer's Glue
have had debt rated Triple-B.
Analysts say the debt could
be a mess in the making
especially if the economy
enters a recession.
To understand why investors are concerned,
you need to understand how
corporate debt is rated.
Think of these ratings as
credit scores for corporations
but instead of using numbers,
ratings firms assign
letter grades from A to D.
The higher the grade, the
less likely the company is
to default on its debt.
Each one of those ratings
is broken down further
into triple, double, and
single-letter categories.
So Triple-A debt is safer than single A.
Triple-B debt sits just above
an important dividing line.
Everything above this line
is considered higher quality
investment-grade debt.
Everything below is
considered risky or junk debt.
It carries a higher risk of default.
The worry is that if the
economy takes a turn,
some Triple-B debt will
slide into junk territory.
A key metric for how these
ratings are assigned is leverage.
Leverage is a ratio of how
much debt a company owes
compared to its earnings.
The more debt a company has
relative to its earnings,
the higher the leverage.
It's an important factor in determining
how safe a company's debt might be.
Since the financial crisis,
companies have a lot more leverage.
In 2009, corporations had a little over
twice as much debt than earnings.
By 2019, that ratio had increased
to about three times earnings.
And when you just look
at Triple-B rated debt,
that ratio is even higher.
This is what's concerning
investors and analysts.
They say that in the past,
companies with this amount of leverage
would have been rated in the junk category
which is far riskier.
This has caused a divisive debate
over whether this debt
will cause big losses
when the economy turns.
- Business debt has
clearly reached a level
that should give businesses and investors
reason to pause and reflect.
If financial economic
conditions were to deteriorate,
overly indebted firms could
well face severe strains.
- For their part, ratings
firms like Moody's and S&P
say other factors also play
a role in assigning ratings.
Having a solid brand and
generating sufficient cash flow
to pay bond holders can
also influence a company
being rated investment-grade.
Ratings firms make predictions
about what a company's leverage ratio
would look like in the future.
For highly leveraged companies,
these predictions can serve as a deadline
to keep their investment-grade status.
If a company doesn't hit its target,
it runs the risk of being downgraded.
But the amount of time
some Triple-B companies
have been given to meet these deadlines
has left some investors
scratching their heads.
In 2018, Moody's said the
Triple-B rating for Campbell Soup
was too high after it
acquired a snack company
for $6.1 billion.
It estimated the company's leverage
had topped five times earnings.
Moody's gave the company until July 2020
to get it below four times earnings.
Ratings firms predicted Newell brands
which makes Elmer's Glue
would reduce its debt
load for multiple years.
When Triple-B rated Newell
announced a multi-billion
dollar acquisition
in December 2015,
S&P and Moody's analysts
predicted its leverage ratio
would fall from more than five times
to under four times
earnings by December 2017.
They continued to make similar predictions
that Newell would be a safe
bet in 2016, 2017, and 2018.
But these 2018 calculations
failed to account
for lost earnings from
businesses Newell had sold.
At the time, Moody's said its calculation
was just a different way
of measuring leverage.
An S&P spokesman told the
Wall Street Journal that,
"Our analysis speaks for itself."
Updated calculations from both firms
showed Newell's debt was
above five times earnings
at the end of 2018
revealing that the bonds
had been a potentially riskier investment
than what the ratings firms indicated.
S&P downgraded Newell's debt
to junk status in November.
Moody's still rates it Triple-B.
But investors still remain skeptical.
More than $100 billion
in investment-grade debt
is trading with yields
that are usually associated
with junk debt.
These bonds are rated Triple-B minus,
the absolute lowest rung
of investment-grade debt.
The Federal Reserve raised the alarm
about the volume of outstanding
Triple-B debt in November
saying that widespread downgrades
during an economic slowdown
could disrupt the liquidity
of the corporate bond market
potentially leaving investors
in a sticky situation.
(whimsical music)
