Coronavirus May Light Fuse on ‘Unexploded Bomb’ of Corporate Debt

LONDON — For years, wonks bearing spreadsheets have warned that corporations around the planet were developing a dangerous addiction to debt. Interest rates were so low that borrowing money was essentially free, enticing companies to avail themselves with abandon. Something bad was bound to happen eventually, leaving borrowers struggling to make their debt payments. Lenders would grow agitated, tightening credit for everyone. The world would confront a fresh crisis.

Something bad is now happening. As the coronavirus outbreak spreads, halting factories from China to Italy, sending stock markets plunging and prompting fears of a worldwide recession, historic levels of corporate debt threaten to intensify the economic damage. Companies facing grave debt burdens may be forced to cut costs, laying off workers and scrapping investments, as they seek to avoid default.

“We have been always saying that we are sitting on top of an unexploded bomb, but we don’t know what is going to trigger it,” said Emre Tiftik, director of Research for Global Policy Initiatives at the Institute of International Finance, a Washington-based financial industry trade group. “Can the coronavirus be a trigger? We don’t know. Maybe.”

By the end of 2019, total outstanding debt among corporations other than financial institutions had surged to a record $13.5 trillion worldwide, according to a recent report by Serdar Çelik and Mats Isaksson for the Organization for Economic Cooperation and Development, the Paris-based research institution. That number has swelled as many companies have sold riskier bonds to finance expansions.

Worries about corporate debt appear to be enhancing the panic that has captured world markets, as investors have dumped riskier assets like stocks in favor of safer holdings like United States government bonds.

The International Monetary Fund last year examined the situation in eight countries including the United States, Japan, China and several European nations. It warned that a shock only half as severe as the global financial crisis would put nearly 40 percent of total corporate debt at risk, meaning that companies would not be able cover their payments with earnings alone.

Not everyone is sounding the alarm. “The prophets of doom who thought that more debt was more risk have generally been wrong for the last 12 years,” said Nicolas Véron, a senior fellow at the Peterson Institute for International Economics in Washington. “More debt has enabled more growth, and even if you have a bit more volatility, it’s still net positive for the economy.”

In contrast to the financial crisis of 2008, few today are worried about the banking system, which holds capital to cover bad loans. The best-financed companies like Apple, Google and Facebook have hundreds of billions of dollars in cash, making them essentially immune to whatever reckoning may lie ahead.

But even some who praise central banks for rescuing the world from catastrophe argue that easy money has outlived its usefulness. Years of loose credit have enabled weak companies to stave off extinction.

“There are whole sectors that survived that should have gone into restructuring,” said Alberto Gallo, head of macro strategies at Algebris Investments, an asset management firm in London. “Retailers in a world of online retail, energy companies with high production costs, small banks in Europe that are not efficient. The availability of funding at very cheap rates has kept zombie companies alive. This means we have an accumulated level of fragility in the economy which can be exposed very easily to real shocks.”

As the coronavirus has spread from Asia to Europe to North America, it has threatened the earnings of companies that have financed their businesses by selling riskier bonds.

The world of bonds can be roughly divided into two realms — those that gain the stamp of approval from credit rating agencies as investment grade, and those deemed to be less secure, bearing so-called junk status. Since 2010, about one-fifth of new corporate bond issuances have been below investment grade, according to the O.E.C.D. Last year, that proportion grew to one-fourth. “Default rates in a future downturn are likely to be higher than in previous credit cycles,” the report said.

Even within the sturdier category, bond markets have taken a pronounced turn toward risk: Last year, 51 percent of all outstanding investment-grade bonds were rated at BBB, the lowest level to qualify for that status, according to the O.E.C.D. That was up from 39 percent before the financial crisis.

That trend is troubling to financial experts because it leaves companies — and the world economy — especially vulnerable to a change in fortunes.

The world’s largest pools of money — asset managers that control pension funds, mutual fund operators, and insurance companies — are typically restricted in where they can invest. Many are obligated to hold the safest bonds.

When corporate bottom lines are threatened, credit ratings can be downgraded. Given that more than half of all investment-grade bonds now occupy the lowest rung of that classification, downgrades could render trillions of dollars’ worth of such holdings effectively radioactive. Money managers would be forced to unload them while buying safer assets. That would make credit tighter for many companies, threatening some with insolvency and constraining economic growth.

This was the situation before the coronavirus began its lethal, wealth-destroying wander around the globe. The widespread disruption to factories across Asia and in Europe, the effective quarantining of all of Italy, and the spread of the outbreak to the United States have threatened the earnings of thousands of companies.