American corporates piled on a ton of debt during the pandemic. Non-financial corporate businesses added $2.5 trillion in debt over the last three years and now owed a staggering $12.7 trillion. Given rapidly rising interest rates—and no clear end in sight, it seems inevitable that higher borrowing cost would eventually start to squeeze corporate profit.
Some may find comfort in the fact that corporate earnings have by and large kept pace with debt, except for the first few months of 2020 when earnings fell off the cliff. See Figure 1. For the period 2019-2022, for every dollar of debt, non-financial corporate businesses have generated earnings (before interest and taxes) of 20 cents, on average.
Figure 1: Non-Financial Corporate Businesses Debt and Earnings: 2019-2022
Corporate borrowing cost have risen furiously in 2022, as shown in Figure 2, which plots the yields on High Quality Market (HQM) corporate bonds with three different maturities. Since HQM bonds comprise of mostly investment-grade bonds, the spike in their yields in recent months suggests that even for the most credit-worthy companies, the day of cheap credit is likely behind us.
Figure 2: High Quality Market Corporate Bond Yield
Corporate bond spread, which is the difference between corporate bond yield and the yield on treasury bond with the same maturity, has also spiked in 2022. In other words, lenders are attaching a higher risk factor to corporate borrowers and accordingly demand a higher interest rate for compensation, compared to the return on risk-free treasury securities. For example, the 10-year corporate bond-treasury spread hovered around 100 bps for the most part since 2018 (except for the early pandemic months) but has risen by as much as 75 bps during 2022. The spread has retreated in early 2023 but remains significantly above historical average.
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