There are three main types of debt: household debt, corporate debt, and government debt. We think the most debate surrounds corporate debt because it is understood households have deleveraged this cycle and government debt has gotten worse. To be clear, there are debates on those categories because some say household debt in specific areas like autos and student loans are a problem and there are endless discussions about whether heightened government debt is a problem.
With corporate debt, we know it can be a problem if it gets out of control, but the question is how bad the situation is. Depending on how you interpret the data, it can look appear like a normal situation or a big problem. One thing we won’t look at is debt to GDP because corporate debt has no relationship to GDP. A corporation with a lot of debt won’t be bailed out by GDP if it can’t make its interest payments. We know there have been exceptions where companies get a government bailout, but as a whole, corporations pay their debt through cash flow or the issuance of more debt which has nothing to do with GDP. Also, and more importantly, most S&P 500 companies and the US publicly traded companies in general, are more global than ever before, so comparing them to the home country GDP is not an accurate measure to gauge indebtedness.
Ratings Are Getting Worse
One of the big disasters from the 2008 financial crisis was the failed debt ratings by the ratings agencies. This cycle, the ratings agencies are determined to avoid making the same mistakes. As you can see from the chart below even though corporate earnings have increased and the economy looks strong, corporate debt ratings have gotten worse.
Source: chart below
The percentage of BBB rated debt has increased to above 40% which is the highest since at least 1997. The percentage of non-BBB rated investment grade debt has fallen to the low 40s. To be clear, BBB rated debt is in the lowest tier of investment-grade debt (BBB- is the worst). Heightened debt levels are hurting corporations’ scores. In 2007 there were 55 corporations with a perfect AAA rating. In 2010, after the financial crisis, it fell to just 27. Now there are only two firms with AAA rated debt: Johnson & Johnson and Microsoft.
