But for those companies needing financing the most, taking on new debt can be expensive. Those added costs come just as their ability to pay is threatened by falling earnings, a consequence of the pandemic-related shutdown.
Despite the risks, this latest borrowing binge — unusual amid a punishing recession — may be the only way to avoid even more short-term pain for the U.S. economy. But the swollen debt means the recovery is likely to be a slow, grinding affair rather than the sharp, election-year rebound the White House covets.
“It’s going to be worse than a wet blanket. It’s going to be a significant head wind to the recovery,” said Michael Farr, founder of Farr, Miller and Washington, an investment firm. “There’s no easy way out of this.”
Heavily indebted companies could slow the recovery by laying off workers and reducing spending to hoard cash in hopes of avoiding bankruptcy. Hertz, which missed an April 29 debt payment, laid off 10,000 workers last month as it fought to avoid a Chapter 11 filing. Excessive borrowing also may dent the long-run prospects of companies that take on even more debt while only deferring what some experts describe as an eventual day of reckoning.
Many companies are accepting the costs of adding more debt to replace the disappeared revenue during the nearly two-month economic shutdown. Some businesses, such as airlines, restaurants and car rental operations, have been especially hard hit by consumers staying home. At Marriott, the world’s largest hotel chain, revenue-per-available-room fell by 90 percent in April, CEO Arne Sorenson told investors Monday.
The new borrowing by companies like Marriott comes after corporate debt soared during the decade after the 2008 financial crisis, as the Fed kept interest rates near zero to spur growth. By the end of last year, the debt bulge topped $10 trillion, up two-thirds since 2010, according to the Fed.
The buildup was especially pronounced in the lowest and riskiest tier of creditworthy companies, just one notch above junk or high-yield debt. By last year, those companies accounted for roughly half of all investment-grade borrowing.
During the boom, chief executives used much of the debt to repurchase their companies’ stock or to increase dividend payments, a boon to current shareholders.
Financial watchdogs at the Fed, the International Monetary Fund and the Bank for International Settlements in Basel, Switzerland, issued frequent warnings that corporations were indulging in risky behavior that could end badly if the economy soured.
Fed Chair Jerome H. Powell last year said companies that had borrowed too much could “come under severe financial strain if the economy deteriorates,” adding that their efforts to save themselves by slashing spending would deepen any downturn.
While borrowing costs were low and business was good, such warnings were easy to disregard. But the outlook has darkened.
In April, 32 companies defaulted on debt payments, the most since May 2009, according to S&P Global Ratings. The ratings agency said it expects this year’s default rate to be more than three times last year’s figure.
So far, the heavy borrowers that have tipped into bankruptcy have been companies that were troubled before the pandemic struck. Traditional retailers, such as J. Crew and Neiman Marcus, long under pressure from e-commerce rivals, were among the first to falter.
More companies may follow. The share of corporate debt regarded as “distressed” — meaning borrowers must pay investors at least 10 percentage points more than Treasury rates — is rising, according to the S&P.
Avis, the car rental company, earlier this month had to promise investors annual interest of 10.5 percent to raise $500 million. The U.S. government, in contrast, pays just 0.3 percent to borrow money for the same five-year period.
Capital Economics, meanwhile, warns that nonfinancial corporations’ ability to repay their debts — reflected in the ratio of their pretax earnings to their interest expenses — is headed to a historic low.
Luke Ellis, chief executive of Man Group, the world’s largest publicly traded hedge fund, said companies struggling now took on too much debt during the long expansion that began in mid-2009.
The pandemic blindsided even well-run companies. But those with too much debt “weren’t able to withstand any shock to their business,” Ellis told CNBC on Tuesday.
“The problem is so much of the economy has run with very little margin for error, and we’re suffering from it now,” Ellis said.
The Fed said it plans to support $750 billion in additional corporate borrowing as a way to “maintain business operations and capacity” while the pandemic has forced many routine commercial activities to cease.
The bond fund purchases that began Tuesday, which can include securities recently downgraded to junk, are just the first step. The central bank also plans to begin buying new bond issues.
Both moves are part of an aggressive crisis-fighting program that could support $4 trillion in total lending for businesses, households and state and local governments.
Just the announcement in late March that the Fed planned for the first time to buy corporate bonds calmed markets that had frozen in the pandemic’s early weeks. Since the Fed weighed in, major companies have sold record amounts of bonds to investors, seeking to stockpile cash to ride out what appears to be the worst economic collapse since the 1930s.
In April, corporations including Nike and Visa issued $296 billion worth of bonds, nearly three times the amount sold during the same month in 2019. On Tuesday, General Motors wrapped up a $4 billion bond offering.
“Fed intervention was extremely important,” said Srikanth Sankaran, global head of credit strategy research for Morgan Stanley. “It prevented an unprecedented financial shock from escalating into a broad-based funding crunch.”
When markets were especially unsettled in late March, bond investors demanded four percentage points above Treasury rates to lend money to corporate borrowers, up from just one percentage point a month earlier. After the Fed announcement, that spread fell to about 2.2 percentage points.
The double-edged nature of the rising debt is evident at Boeing, which flirted with a government bailout before deciding to tap investors for cash. The aircraft maker completed a mammoth $25 billion debt offering last month, but it didn’t come cheap.
The new debt will add more than $1.2 billion to Boeing’s annual interest expenses, according to analyst Robert Stallard, who follows the company for Vertical Research Partners. That will more than double the company’s annual interest bill, according to its filings with the Securities and Exchange Commission.
“Boeing is now arguably owned by the banks,” Stallard said in a May 1 research note.
The company’s debt burden will make it difficult to invest enough in new product development, putting its market dominance at risk, he added. As it seeks to whittle down its debt pile, it also will be unable to pay shareholder dividends.
David Calhoun, Boeing’s chief executive, told investors last month on an earnings call the company plans “immediately” to reduce its debt once business returns to normal and “will not lose sight of making necessary investments” as it does so.
Adding more debt at this stage in the economic cycle worries some bond market veterans.
In the past three recessions, total corporate obligations peaked during the downturn and then began falling, according to the Bank for International Settlements. In the 2008 financial crisis, total credit to financial corporations — a broad measure of debt — peaked in the months following the collapse of the investment bank Lehman Brothers. Over the next four years, it fell as a share of the economy by almost seven percentage points of gross domestic product.
A continuing rise in corporate borrowing as the economy shrinks, which appears to be underway, would be worrisome, according to Peter Fisher, former head of fixed income at BlackRock.
“This doesn’t make sense: Overall corporate indebtedness relative to the economy usually contracts during and after recessions,” said Fisher, who served as undersecretary of the Treasury for domestic finance in the George W. Bush administration.
In Fisher’s view, the economy would be better off if companies were forced to write down their debts in bankruptcy or restructuring, something he said must happen eventually. If those losses are not realized, and debt instead increases further, the recovery is likely to suffer, he said.
But so long as the Fed keeps borrowing costs ultralow — something it has pledged to do until the economy rebounds — that showdown with creditors can probably be postponed.
“We’ve just become completely addicted to debt,” said economist Megan Greene, a senior fellow at Harvard University’s Kennedy School of Government. “That is unsustainable — but it can be sustained for a very long time.”