– 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)