Our Head of Corporate Credit Research explains how corporate
balance sheets have remained resilient post-COVID, and why that
could continue in the face of a potential economic slowdown.
----- Transcript -----
Welcome to Thoughts on the Market. I'm Andrew Sheets, head of
Corporate Credit Research at Morgan Stanley. Along with my
colleagues bringing you a variety of perspectives, today I'll
discuss how corporate balance sheets are in a better place to
handle a potential growth slowdown.
It's Friday, August 16th at 2pm in London.
Much of the volatility over the last several weeks has been
centered around fears that excessively high interest rates from
the Federal Reserve will now cause the US economy to slow too
quickly. Morgan Stanley’s economists are more optimistic and
believe that the data will hold up, leading the Fed to start a
gradual rate cutting cycle in September, rather than a more
radical course-correction. Against this backdrop, good economic
data is good for markets and vice versa.
But even though we remain optimistic at Morgan Stanley about a
soft landing in the US economy, our economists still expect
growth to slow. How prepared are corporate balance sheets for
that slowing, and how worried should we be that this could lead
to higher rates of default?
A good place to start is thinking about how optimistic companies
were heading into any slowdown of the economy. Overconfidence is
often the enemy of credit investors, as rose-tinted glasses can
lead companies to make too many unwise acquisitions or
investments, funded with too much debt.
Yet across a variety of metrics, this isn’t what we see. Despite
some of the lowest interest rates in human history, the level of
debt to cash-flow for US and European companies has been pretty
stable over the last five years. Excess capital held by banks
remains historically high. And Merger and Acquisition activity,
another key measure of corporate confidence, remains well below
the long run trend – even after a pick up this year, as my
colleague Ariana Salvatore discussed on this program earlier in
the week.
So, despite the strong recovery in the US economy and the stock
market over the last four years, many corporate boardrooms have
remained cautious, a good thing when considering their financial
risk.
Where Corporate debt did increase, it was often in places that we
think could withstand it. Large-cap Technology and
Pharmaceuticals issuers have taken out more debt over the last
several years, relative to history, but it's been a pretty modest
amount from a pretty low historical starting point. The Utility
sector has also taken on more debt recently, but the stable
nature of its business may make this easier to handle.
While companies across the ratings spectrum generally didn’t
increase their leverage over the last several years, they did
take advantage of refinancing the debt they already had at
historically low rates. And this is important for thinking about
the stress that higher interest rates could eventually
produce.
The average maturity in the US Investment Grade index is about 11
years, and that means that, for many companies, potentially less
than one-tenth of their overall debt resets to the current
interest rate every year. That means companies may still have
many years of enjoying the low interest rates of the past, and
that helps smooth the adjustment to higher interest rates in the
future.
The lack of corporate confidence since COVID means that corporate
balance sheets are generally in a better place if the economy
potentially slows. But while this is helpful overall, it’s
important to note that it doesn’t apply in all cases. We still
see plenty of dispersion between winners and losers, driving
divergence under the hood of the credit market. Even if balance
sheets are stronger overall, there is plenty of opportunity to
pick your spots.
Thanks for listening. If you enjoy the show, leave us a review
wherever you listen and share Thoughts on the Market with a
friend or colleague today.
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