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Leverage Continues To Climb--Has It Finally Peaked


- Excessive leverage lowers issuers' financial flexibility and increases reliance on stable capital markets.

- Exacerbated volatility when the credit cycle turns may give rise to liquidity stress and potential defaults if market access is limited.

- With overseas cash more easily fungible, debt issuance to fund shareholder-friendly activity will most likely begin to deaccelerate.

Oct. 09 2018 — U.S. corporate leverage continues to climb, with the amount of debt that U.S. corporate borrowers are carrying on their balance sheets at an all-time high. This record leverage makes speculative-grade borrowers more vulnerable to downgrades and defaults, when the credit cycle turns.

Debt-to-EBITDA and funds from operations (FFO)-to-debt ratios are just two of the measures S&P Global Ratings uses to calculate leverage among borrowers we rate (see “Corporate Methodology: Ratios And Adjustments,” published Nov. 19, 2013). And while we take into account sector-specific factors such as earnings volatility when determining a borrower's stand-alone credit profile (SACP), the fact remains that as of Sept. 18, leverage across the rated universe of more than 2,300 U.S. nonfinancial corporate borrowers is at a historic high. We believe the risks attributable from this debt binge are significant, given excessive leverage can leave a company more vulnerable to disruptive business conditions and rising financing costs.

Given where we are in the credit cycle, there are concerns about how and when prevailing conditions will turn. Such a change could spark bouts of strong volatility, and periods of rapidly rising financing costs and illiquidity--limiting borrowers' financial flexibility--giving rise to increased defaults.

This isn't to say that adding leverage doesn't come with some benefits. In turn, a significant amount of debt proceeds have been used post-financial crisis to fund mergers and acquisitions (M&A), capital expenditures, and other strategic business initiatives that in many cases have benefitted margins and revenue stability. In addition, debt issuance proceeds over the past several years has been used to gain market share, grow top- and bottom-line earnings, and supplement organic revenue growth challenges.

As a result however of this debt binge, the median debt level among rated U.S. corporate borrowers now exceeds comparable metrics immediately prior to the most recent financial crisis (see charts 1, 2, and 3). Many companies have borrowed opportunistically, taking advantage of some of the lowest interest rates the U.S. has ever seen.

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