Keeping an Eye on Heavy Corporate Debt

The opportunity to borrow at low interest rates has enticed corporations to issue more than $1.0 trillion in bonds every year since 2010. By the end of 2018, corporate balance sheets were carrying $9.1 trillion in debt, up from $5.5 trillion in 2008.1 As a result, corporate leverage amounts to about 46% of U.S. gross domestic product (GDP), matching levels reached during the last financial crisis.2

Corporations sell bonds to finance operations and capital investment. In recent years, more companies have used debt to fund costly acquisitions that may or may not improve future profit margins or growth prospects.3

Now that interest rates are on the upswing, one big-picture concern for investors is whether heavy corporate debt will become a threat to the U.S. economy. If you rely on corporate bonds for retirement income or to help temper the effects of stock market volatility, you might also consider the potential impact on your fixed-income portfolio.

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The ABCs of Risk and Ratings

Corporate bonds usually offer higher interest rates than U.S. Treasury securities with comparable maturities. Whereas Treasuries are guaranteed by the federal government as to the timely payment of principal and interest, corporate bonds are not guaranteed and depend on the financial strength of the issuing company.

Most corporate bonds are evaluated for credit quality by one or more ratings agencies, each of which assigns a rating based on its assessment of the issuer’s ability to pay the interest and principal as scheduled. Investment-grade bonds are generally rated BBB or higher by Standard & Poor’s and Fitch Ratings, and Baa or higher by Moody’s Investors Service. Non-investment-grade bonds (also called high-yield or “junk” bonds) are issued by companies that pose a greater risk of default. Bond investors generally expect a higher interest rate as compensation for bearing the additional risk.

Many factors can alter a company’s perceived credit risk, including shifts in economic or market conditions, adjustments to taxes or regulations, a