Why growing corporate debt may not be as potentially troubling as it seems, according to Deloitte.
U.S. corporate debt had been on the rise since 2010, when the economy recovered from the previous recession, and that trend continued last year during the COVID-19 pandemic. At the end of 2020, the total debt outstanding for nonfinancial businesses in the United States was about $17.7 trillion.
Which companies have been driving the debt binge? Which companies are well-placed financially to repay this debt? And what has been the effect on investments?
To find out, we looked at key financial data for the top 1,000 nonfinancial corporations by market value as of April 2021 from S&P Capital IQ.1 We first ranked companies in descending order of market value and then created five cohorts: top-10, 11–50, 51–100, 101–500, and 501–1,000. Top-10 refers to the 10 highest valued companies, 11–50 refers to the group of 40 companies that follow the top-10, and so on. We also organized the data by sector and analyzed trends in debt, ability to pay, and investments for the 10 primary sectors in which these 1,000 companies operate.
Here are the three trends that emerged:
- As the economy changes, so do companies that drive debt accumulation.
Since 2000, total long-term debt for these 1,000 companies has grown at 9.2% on average per year to $5.8 trillion in 2020. More debt was accumulated since 2010 compared to between 2000 and 2010. For example, between 2010 and 2019, long-term debt grew at an average annual rate of 9.7%, higher than the 8.2% rise between 2000 and 2010. And in line with the trend for total nonfinancial corporate debt in the economy, debt for the 1,000 companies in our research universe increased at a faster pace in 2020 (14.5%) compared to the year before (8.5%).
Analysis of the data by cohorts reveals that the top 50 companies by market value are leading the debt surge. Between 2010 and 2019, the share of the top-10 in total debt for the 1,000 companies more than doubled to 5.7%, before declining slightly last year. During this period, the share of the 11–50 cohort also rose, but at a slower pace than the top-10. This broad trend in rising shares for the 50 largest companies, taken together, has mostly been at the expense of the 51–100 cohort. The figure below also reveals that a mere 5% of these 1,000 companies accounted for 30.7% of the group’s total long-term debt.
Three sectors—information technology, communication services, and health care—have been leading debt growth since 2010, corresponding to these sectors’ growing prominence in the wider business activity. Beyond that, these sectors rapidly increased their debt even during the pandemic. Rising debt for these sectors isn’t surprising given that in the top-10 cohort, four companies are from information technology, two from communication services, and one from health care. And in the 11–50 cohort, 65% of companies are from these three sectors.
- Ability to repay debt has deteriorated for all companies, except very large ones.
For most groups of companies, rising debt has accompanied deteriorating ability to repay. The ratio of net debt to earnings before interest, taxes, depreciation, and amortization (EBITDA) has been increasing since the early- and mid-2010s. In the pandemic, earnings dropped even as debt increased, thereby denting companies’ ability to repay debt. For example, EBITDA declined by 18.2% for the 501–1,000 cohort and by 16.7% for the 101–500 group in 2020. The top-10 cohort, however, appears to be better placed than others in its net-debt-to-EBITDA ratio In 2020, EBITDA declined the most for energy (42.7%)—most likely due to a sharp drop in oil prices last year—and industrials (33.8%). This, in turn, ensured that their net-debt-to-EBITDA ratios deteriorated sharply, given that net debt soared.
The pandemic also curbed companies’ ability to pay interest on their debt. The interest coverage ratio, a ratio of earnings before interest and taxes (EBIT) to interest expenses, fell for all cohorts other than the top-10 in 2020, with the quantum of decline being the highest for the 101–500 cohort. While low interest rates helped in keeping interest expenses in check for all cohorts last year, it was the sharp fall in earnings that dented some cohorts’ interest coverage ratio. As with net-debt-to-EBITDA ratio, larger companies as a group seem to be better placed than their smaller counterparts in terms of interest coverage. Among key sectors, information technology had the highest interest coverage ratio in 2020, unchanged from the previous year. The number, however, has gone down sharply over the years. The energy sector witnessed a similar trend. With earnings being hit in 2020, most sectors saw declines in the interest coverage ratio. The energy sector was the worst hit.
- Capital expenditure hasn’t kept pace with debt, with 2020 being an especially bad year
Has this debt surge been matched by an increase in investments? If so, it should be a positive trend for the economy. If not, this high level of debt may become a problem.
But data on investments by these 1,000 companies reveals that overall capital expenditure (capex) hasn’t kept up with debt growth. Between 2010 and 2019, for example, capex grew by 6.7% on average per year, lower than the corresponding growth in long-term debt (9.7%). And even as debt grew in 2020, capex fell by 9.4%—although there is quite a bit of variation within company cohorts. The top-10 group, which has led debt expansion, has also increased capex faster than others. This group is the only cohort that increased capex amid the pandemic and at a healthy pace. Oddly, the 11–50 group, which like the top-10 contributed strongly to overall debt expansion between 2010 and 2019 (and 2020), witnessed slower capex growth on average during this period compared to 2000–2010.
Capex growth has been the highest since 2010 for the consumer discretionary, information technology, and health care sectors, while it has contracted for energy. In fact, capex fell by a staggering 38.3% last year for energy, a contrast to strong growth in long-term debt for the sector that year.
Is Rising Debt a Problem?
The capex trend in 2020 could well give a misleading impression of the direction of future productivity growth.
First, capex includes investment in structures (which are not closely associated with productivity improvements), as well as in maintenance. Second, although business investment fell in the first half of 2020, the types of business investment most closely tied to productivity growth staged a remarkable recovery in the second half that has continued into the first quarter of 2021.
Two types of investments closely associated with the economy’s productivity growth—investment in information processing equipment (including investment in computers, communications, medical, and accounting equipment) and investment in software—expanded rapidly during the pandemic. In fact, after falling in the first quarter of 2020, investment in information processing equipment exploded as businesses worked to adapt to a host of challenges posed by COVID-19.2 Investment in software did not see explosive growth, but after falling in Q2 2020, this investment class has been growing faster than its pre-pandemic rate.
In such a low interest-rate environment, higher debt levels are not necessarily bad, although a deterioration in the ability to repay is a concern. The ultimate impact on the economy and the businesses themselves hinges on how this debt is used. Preliminary data suggests some of the investments that they and their companies are making are smart ones—the kind that will augment productivity in the future.
—by Patricia Buckley, managing director, Economic Policy and Analysis, Deloitte Services LP; Akrur Barua, executive manager/economist, Deloitte Services India Pvt. Ltd.; Monali Samaddar,senior analyst/economist, Deloitte Services India Pvt. Ltd.