With record high corporate debt many experts are concerned that the stock market, bond market and overall economy will be negatively affected. Currently, there is approximately $5.5 trillion dollars of corporate debt in America.
The approximate break down is:
-$1.3 trillion in leveraged loans
-$1.2 trillion in junk bonds
-$3 trillion in investment grade corporate debt
The concern with these types of corporate bonding, aside from the amount of money being borrowed for corporations, is the way the money is being borrowed. The types of loans and bonds being taken out are reminiscent of the types of deals that were put together in 2007 before the crash and the beginning of the great recession. Before it was mortgages for buyers who were at high risk of defaulting, and currently it is bond and loan packages for high-risk companies and individuals.
The risk is that the loans and bonds are being taken by companies who have a large amount of current debt and/or those who don’t have good credit history. Exchange Traded Funds (ETF) are being put together for high-risk borrowers that are full of junk bonds and other investments that resemble deals that were put together prior to the great recession and also similar to before, they are passing as AAA rated bonds, even though they are only investment and junk grade bonds.
So what does all of this mean? Why are these types of bonds and loans so potentially dangerous for the economy?
What are leveraged loans?
This type of loan is most often offered to companies and individuals with poor credit history and a high level of current debt. Often these are new start-ups or failing companies who need cash flow to get or stay afloat.
These loans have a high-risk of for default because of the credit history and current loan amounts.
Most costly for borrowers due to high interest rates. This is also a large risk for lenders because the borrowers may not be able to keep up on the payments.
What are junk bonds?
These bonds are for companies who have a high level of existing credit and/or poor credit history.
They bonds are issued by corporations and the government for investors looking to receive high dividends from high interest rates invested in the principal amount of the bond in return for purchasing and funding the bonds for companies that need the capital.
Most bonds pay investors yearly interest payments.
The bonds attract investors because they have high interest rates and promise more income, even though they are also a higher risk for default due to the history and current debt of the client.
What is investment grade corporate debt?
This type of debt has a high level of risk for corporations and municipal bonds.
Different bond rating agencies have different symbols and grade for each bond. It is important to know what the rating is. Though many ETF packages are AAA rated even though they are loaded with junk bonds.
The overall concern with bonds and loans being lent to corporations today is that they are almost all at risk for default and they are funding many failing companies. If the companies and individuals being lent the money default, they money is lost. If this keeps happening, corporations will lose money and affect they economy long term. It is much better when the loans and bonds are funding stable companies with high credit ratings and low current debt, rather than what is being done in the current market. The most unfortunate part of all of this, is that history is repeating itself and if it does, the question is really not “if” the bubble will burst, but “when” it will burst.