By Jack McCabe
That is the takeaway from a recent post on the New York Fed’s Liberty Street Economics blog by Anna Kovner and Brandon Zborowski of the bank’s research and statistics group. In the post, they examine what the build-up in nonfinancial corporate debt means for the economy.
As explained in the recent Federal Reserve Financial Stability Report, high corporate debt can pose a risk to financial stability since heavily indebted businesses tend to cut back on spending when hit with a shock, the authors note. Also, while asset quality is currently very strong, financial institutions and investors suffer when these businesses cannot pay back their loans.
Corporate debt to GDP has increased throughout the ongoing economic expansion, reaching a record high of 46 percent. Corporate profits have also risen since the Great Recession, increasing businesses’ ability to manage their debt. When analyzing the debt and profits picture at the individual business level, the authors find that the riskiest public corporations have levered up the most. This is causing the rising concern about leveraged lending, which is mostly being driven by nonbank lenders. However, some of this growth has slowed as profits have grown at a strong rate over the last year.
The authors also look at a few other measures of debt, including debt-to-book assets, debt-to-market capitalization, and the interest coverage ratio (EBITDA-to-interest expense). The debt-to-book assets ratio has risen since 2014, but may overstate leverage if book values are less than market values. Due to elevated levels of the equity market, debt-to-market capitalization has decreased to below its historical median, but this measure may understate leverage if market values are high relative to earnings. The interest coverage ratio remains above its historical median thanks to strong earnings growth, even as interest rates have increased over the last two years.