Improved Earnings Doesn’t Mean Corporate Debt is out of the Woods

Corporate debt levels will remain an issue in 2018, according to S&P Global Ratings analysts, despite corporations seeing relief in their earnings and cash flow, some of which is thanks to the recent U.S. tax bill.

In a 2018 study of 13,000 corporate issuers, analysts reported that although corporate earnings have improved and default rates are currently low, the steep corporate indebtedness brings risk of lower asset prices and liquidity reversals. The debt-to-earnings ratio improved slightly from 2016 to 2017, but was still higher than the numbers that were recorded in the past decade.

Last month’s market volatility brought about a weak U.S. dollar, the report said, and when combined with rising commodity prices and improving economic growth, a snowball effect may follow, beginning with inflation and then a repricing in risk assets and spike in higher interest rates.

“High corporate debt levels have increased the sensitivity of borrowers to elevated financing costs,” S&P Global’s Head of Analytics and Research in Asia-Pacific Terry Chan said in a Feb. 5 Barron’s article. “Removing the easy money punch bowl could trigger the next default cycle.”

However, Moody’s Investors Services reported a more positive outlook for corporations. Analyst Julia Chursin said in a report that more corporate ratings improved than companies defaulted; therefore, the default rate for high-yield bonds could continue to fall.

—Andrew Michaels, editorial associate

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