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leverage levels rising across regions and sectors

June 2018

Corporate borrowing: cause for caution?

Corporate indebtedness has been creeping up. For some sectors and regions it is at 20-year highs. As rates rise this may become a problem.

Could corporate borrowing trigger the next financial crisis? There are certainly grounds for concern. The IMF has warned that there is more debt in the world now than at the height of the financial crisis. And, as interest rates rise and liquidity conditions tighten, heavily indebted companies are likely to find it harder to repay their debt or refinance borrowing.

So which assets are most at risk? Our research shows that several sectors’ (ex-financials) leverage, as measured by net-debt-to trend EBITDA (earnings before tax, interest, deprecation and amortisation) ratio, is at the top of its 20 year range (see chart). Companies operating in the energy sector, for example, have gone from being among the least indebted to among the most, as US firms in particular have been investing in shale infrastructure in to boost growth. Healthcare, consumer staples and utilities companies – all traditionally considered stable, defensive firms – are also borrowing more than they have historically, partly to finance buybacks. If this trend continues, their haven status could come under threat.

Gorging on debt?

Sector comparison of global net debt to trend EBITDA regions, ex-financials

Debt comparison between sectors

Source: Datastream, Pictet Asset Management. Data covering period: 01.06.1998 – 01.06.2018.

Although real estate remains the most indebted of the non-financial sectors, with a net debt-to-trend EBITDA ratio of 4.5 times, its ranking masks hefty deleveraging from a peak of 6.6 times a decade ago.

Of the major regions, only Japan has steadily and significantly lowered its debt ratio over the past 20 years, more than halving it to 1.3 times (see chart).

The borrowers

Regional comparison of net debt to trend EBITDA ratios, ex-financials

Debt comparison between regions

Source: Datastream, Pictet Asset Management. Data covering period: 01.06.1998 – 01.06.2018.

By contrast, the UK’s borrowing has risen steeply and the US is near peak levels of leverage.

Overall, then, both at country and sector level, there are pockets of high indebtedness which may prove troublesome as interest rates rise and liquidity ebbs. These risks are not always reflected in market valuations. We are not there yet, but when the next financial market crisis hits, the corporate sector could be well the cause.