Learning Center

Back

Keeping an Eye on Heavy Corporate Debt

The opportunity to borrow at low interest rates has enticed corporations to issue more than $1.0 trillion in bonds every year since 2010. By the end of 2018, corporate balance sheets were carrying $9.1 trillion in debt, up from $5.5 trillion in 2008.1 As a result, corporate leverage amounts to about 46% of U.S. gross domestic product (GDP), matching levels reached during the last financial crisis.2

Corporations sell bonds to finance operations and capital investment. In recent years, more companies have used debt to fund costly acquisitions that may or may not improve future profit margins or growth prospects.3

Now that interest rates are on the upswing, one big-picture concern for investors is whether heavy corporate debt will become a threat to the U.S. economy. If you rely on corporate bonds for retirement income or to help temper the effects of stock market volatility, you might also consider the potential impact on your fixed-income portfolio.

IMAGE

The ABCs of Risk and Ratings

Corporate bonds usually offer higher interest rates than U.S. Treasury securities with comparable maturities. Whereas Treasuries are guaranteed by the federal government as to the timely payment of principal and interest, corporate bonds are not guaranteed and depend on the financial strength of the issuing company.

Most corporate bonds are evaluated for credit quality by one or more ratings agencies, each of which assigns a rating based on its assessment of the issuer’s ability to pay the interest and principal as scheduled. Investment-grade bonds are generally rated BBB or higher by Standard & Poor’s and Fitch Ratings, and Baa or higher by Moody’s Investors Service. Non-investment-grade bonds (also called high-yield or “junk” bonds) are issued by companies that pose a greater risk of default. Bond investors generally expect a higher interest rate as compensation for bearing the additional risk.

Many factors can alter a company’s perceived credit risk, including shifts in economic or market conditions, adjustments to taxes or regulations, and changes in management or projected earnings. When a ratings agency upgrades or downgrades a company’s credit rating, or even adjusts the outlook, it often causes the prices of outstanding bonds to fluctuate.

Anticipating Fallen Angels

Some companies have taken advantage of very low rates and favorable terms, putting them in good shape to repay their debt over a long period of time. But those that must refinance their maturing debt will likely face higher borrowing costs, and struggling firms might find it difficult to access credit.

Many companies have borrowed as much as possible without incurring a junk rating, resulting in a surge of debt issuance at the lowest rungs of the investment-grade ladder. At the end of 2018, more than 50% of U.S. corporate bonds were rated in the BBB tier — one step above junk — compared with about 34% a decade ago.4

Debt payments should remain manageable as long as the economy and corporate earnings are growing. But heavy debt loads may be harder to carry in the next downturn, and an unprecedented number of bonds could be downgraded to junk.5

Bonds that lose their investment-grade ratings are known as fallen angels, and they are immediately removed from the investment-grade indexes that track them. Bond funds that are required to keep only investment-grade bonds in their portfolios may have to sell junk-rated bonds at steep discounts, which could push down fund prices.

Performance Under Pressure

As a category, U.S. investment-grade corporate bonds posted a loss of about 2.5% in 2018, making it the worst year for returns since 2008. Concerns about the deteriorating credit quality of bonds issued by some well-known companies were partly to blame.6 And rising interest rates placed downward pressure on fixed-income investments in general.

Corporate bonds overall are lower quality and appear to carry more risk than they have in the past. However, a recent report by Fitch Ratings contends that the rise in BBB-rated bonds may not produce the feared wave of fallen angels in the next downturn. Many companies with low investment-grade ratings also have the financial flexibility to maintain their credit ratings by reducing dividends and other payouts to investors.7

And while the U.S. economy may be slowing a bit, it doesn’t seem to be speeding toward a recession. The Federal Reserve’s latest forecast for 2019 GDP growth was 2.3%, down from an estimated growth of around 3.0% for 2018.8

Some companies and industries are more heavily indebted and/or may be more vulnerable to business cycle transitions than others. Considering the uncertainty, you may want to take a more cautious and selective approach when evaluating corporate bond investments.

The principal value of bonds may fluctuate with changes in interest rates and market conditions. Bonds redeemed prior to maturity may be worth more or less than their original cost. Bond funds are subject to the same inflation, interest rate, and credit risks associated with their underlying bonds. As interest rates rise, bond prices typically fall, which can adversely affect bond fund performance.

Mutual funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

 

Information provided has been prepared from Broadridge Advisor Solutions sources and data we believe to be accurate, but we make no representation as to its accuracy or completeness. Data and information is provided for informational purposes only, and is not intended for solicitation or trading purposes. Broadridge Advisor Solutions is not an affiliate of AXA Advisors, LLC. Please consult your tax and legal advisors regarding your individual situation. Neither AXA Advisors nor any of the data provided by AXA Advisors or its content providers, such as Broadridge Advisor Solutions, shall be liable for any errors or delays in the content, or for the actions taken in reliance therein. By accessing the AXA Advisors website, a user agrees to abide by the terms and conditions of the site including not redistributing the information found therein.

Securities offered through AXA Advisors, LLC (NY, NY 212-314-4600), member FINRA, SIPC. Annuity and insurance products offered through AXA Network, LLC and its subsidiaries.

California Insurance License #: 0F74731

The Retirement Planning Specialist title is awarded by AXA Advisors, based upon the Financial Professional's (FP) receipt of a Certificate in Retirement Planning from the Wharton School, University of Pennsylvania. In a collaboration between the Wharton School and AXA Advisors' affiliate, AXA Equitable Life Insurance Company (NY, NY), coursework for the certificate was developed exclusively for AXA Advisors FPs, and the title may be used only by FPs who have completed the required coursework and maintain the title through ongoing continuing education requirements. To verify that an FP has earned and holds the title in good standing, contact AXA Equitable atretirement@axa-equitable.com. Complaints about an AXA Advisors FP should be directed to customer.relations@axa-equitable.com.

Securities offered through AXA Advisors, LLC (212-314-4600), member FINRA/SIPC. Investment advisory products and services offered through AXA Advisors, LLC, an investment advisor registered with the SEC. Annuity and insurance products offered through AXA Network, LLC and its insurance agency subsidiaries. AXA Network, LLC does business in California as AXA Network Insurance Agency of California, LLC and, in Utah, AXA Network Insurance Agency of Utah, LLC. AXA Advisors and its affiliates do not provide tax or legal advice. Individuals may transact business and/or respond to inquiries only in state(s) in which they are properly registered and/or licensed. The information in this web site is not investment or securities advice and does not constitute an offer.

Blue Ridge Financial Partners is not owned or operated by AXA Advisors or AXA Network.

AXA Equitable Holdings, Inc. is a publicly traded corporation, and it and its subsidiaries are currently using trademarks including the "AXA" name, AXA logo and associated trademarks of AXA SA under license.

Link to axa.com

Privacy Policy

Check the background of this financial professional on FINRA's BrokerCheck
Check the background of this financial professional on FINRA's BrokerCheck