Monday, May 14, 2012

The World's Impending Corporate Debt Wall

Updated October 22nd, 2012

Some months back, I posted an article that outlined the dangers of the world's overall sovereign, corporate and household debt levels in an posting entitled "The Debt Break Over Point - When is too much, too much?".  In this article, I noted that debt is a two-edged sword; while it is needed for economic expansion, debt growth of all types can quite quickly mount to levels that are unsustainable.  When these levels are reached, further increases in the amount of debt can actually cause economic contraction.  The world is finding itself very close or past the point of no return; the level of the world's total debt load has risen relentlessly over the past three decades from 167 percent of GDP in 1980 to 314 percent of GDP in 2010.

Over the past two years, the mainstream media has devoted many pages and a great deal of airtime to two debt issues; the increasingly alarming sovereign debt issue facing the world and the increasing levels of consumer indebtedness in Canada and other nations.  One issue that has pretty much received a pass has been the level of corporate debt.  Fortunately, Standard & Poor's has now released an analysis showing where the dangers of corporate debt may lie in the coming years in their "The Credit Overhang: Is A $46 Trillion Perfect Storm Brewing?".

Standard & Poor's opens by noting that, over the period from 2012 to 2016, there is a huge "global wall" of nonfinancial corporate debt maturing.  On top of that, over the five year period, corporations will require additional debt to fund capital expansions.  Over the five year period, S&P estimates that corporations will require between $43 trillion and $46 trillion in debt refinancing and new debt.  To put this absolutely stunning number into perspective, according to the Economist Global Debt Clock, the world's current global public debt is $48.9 trillion as shown on this screen capture:

Here is a chart showing the new corporate debt that will be required over the next five years by geographic area (in millions of USD):

In total, the world's nonfinancial corporations will require between $12.875 trillion and $15.986 trillion, depending on how quickly corporate debt grows compared to growth in GDP.  Keep in mind that the entire sovereign debt of the United States, the world's most indebted nation in nominal terms, is  $15.7 trillion.

Here is a chart showing the current level of outstanding nonfinancial corporate debt by geographic region and by type of debt along with the 2011 GDP for each region:

Standard & Poor's estimates that three quarters of this outstanding debt will come due during the five year period between 2012 and 2016 with the developed economies of Europe, the United States and the United Kingdom responsible for 55 percent of the total.  China's nonfinancial corporate debt, while large compared to its GDP, consists largely of loans from state-owned banks to state-owned enterprises.

Here is a bar graph that quite graphically (weak pun) shows the height of the "debt wall" with new debt in green and the amount of debt rolling over in grey:

S&P states that the demand for corporate debt could overwhelm the world's banking system as banks look to restructure their weakened balance sheets (particularly in Europe) to meet capital ratios and liquidity requirements.  On top of that, the world's bond holders are looking for safe-haven fixed income investments; as they flee to the shrinking supply of triple-A-rated bonds, they may choose to ignore all but the least risky new corporate issues.  This may result in corporations having to raise yields on their new and refinanced debt to attract sufficient buyers if they choose the bond route for refinancing.  

The report suggests that the global banking system and the world's bond markets will be able to supply the necessary capital for corporations to continue to finance themselves, however, the current situation is extremely fragile.  The ever-increasing levels of sovereign debt have trimmed government's ability to bail out the system as they did in 2008 - 2009 because they are dealing with their own debt and deficit demons.  Extreme levels of volatility in government debt interest rates in Europe are a greatly complicating factor for corporations in that geographical area.  As I noted in this article, we could well be entering a perfect credit storm where both governments and corporations (and by extension, households as the debt problem trickles downward) are unable to find funding; corporations in particular could find themselves "crowded out" of the world's credit markets.  Here is a quote from the S&P report which nicely summarizes the issues facing the corporate world:

"Will capital market constituents have the capacity to provide the new "bricks" required to extend the maturity wall and spark economic growth? Much will depend on the continued ability of banking system regulators to pilot a path through the minefield that lies ahead. Governments and central banks globally have utilized many financial tools in their arsenals to stabilize the financial system and strengthen bank balance sheets. In conjunction with the global financial markets showing signs of stability, monetary and fiscal policies quickly shifted to focusing on restoring economic stability and growth. However, this highly accommodative monetary policy, centered on expanding the monetary base and maintaining artificially low interest rates, is likely to produce only a fragile recovery at best, and could easily be thrown off course at any moment. Key risks that could challenge the policy consensus include a backlash to the austerity measures introduced in debtor countries in Europe, escalating oil and commodity prices (possibly triggered by further geopolitical unrest in the Middle East), and a potential material slowdown of growth in China." (my bold)

The greatest risk appears to be the $13 to $16 trillion in new debt that will be required over the next five years.  This problem appears particularly acute in Europe which has a much less developed corporate bond market than what has been in place in the United States over the past three years.  American debt markets have proven that they can supply $400 billion per year of new funding, that is in sharp contrast to Europe which has exceeded the $100 billion mark in only two years of the past ten.  This may force European corporations to look to the American debt market for financing.

In summary, here is the second last paragraph from the report:

"Lastly, much of the funding available for corporate borrowers over the past few years has depended on the utilization of many financial tools by central banks to mitigate problems, stabilize the financial system, and spark an economic recovery. If the spectre of inflation rises, we could see a tremendous increase in funding pressures. So, at best, we are currently at a fragile peace. At worst, we have created the makings of a perfect storm for the future." (my bold)

Fragile indeed.  I couldn't have said it better.'


  1. I have a couple of independent thoughts on the matter. First off, the talk of "the sky is falling" is meant to resonate with paranoid people - to scare them in order to manipulate them in to doing what the powers that be want them to. All countries are creating debt, so I don't buy that the sky is going to fall per say. Money (currency) is nothing more than a mechanism to put a value on productivity. The distribution of that value has become based on whoever has the most influence on political policy.

    Secondly, debt has been created as a way to steal value from the future and bring it into the present. For example, owning a house you cannot afford to pay cash for means you have to borrow (in effect, from the future) to get it now. In order for that value to be created as additional value so that you are not "stealing" from the future, productivity needs to increase. The problem we have today is that the value of that productivity increase is not being distributed equitably.

    For example, manufacturing has always been a productivity engine. It distributes the value from the owners down through the employees. When the manufacturing process becomes more automated, employees are replaced by machines (robots, computers, etc.) Machines don't get paid, they don't buy houses, etc. (They do consume energy - but that is a separate topic.) The machine replaces far more people than it takes to keep it running, otherwise, it wouldn't be worth the cost. This creates a relative imbalance (compared to anytime in history) of the distribution of the value of productivity.

    More of the value of the productivity increase is going to the relatively fewer number of people involved, and an increasing share of that is going to the owners. This leaves a greater number of people out of the loop.

    The statistics on wealth inequality is proof of this trend. A much greater share of total income that is created, is going to a relatively smaller group of people. This is the reason why debt is a problem. Debt takes an equal share of future productivity value and distributes it unequally. At least, that is the way it seems to be working out.

  2. Thanks for this excellent article. A lot of Chinese non-financial corporate debt is owed by state owned corporations to state owned banks. What happens if these loans go bad? The state owing itself money? A lot of the loans were used for development, building houses and infrastructure that remain largely empty and unused. If the houses remain unsold by the time the debt used to build them matures, how will the debt be repaid?

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