Is Higher Debt Among Companies Something to Worry About?

August 25, 2016

As the Federal Reserve maintains interest rates at all time lows, corporate balance sheets continue to benefit from this accommodative environment, as the low rate environment combined with a bull market has allowed corporations to add leverage to their balance sheets at an alarming rate. With borrowing costs so low, corporations have used this debt to finance stock buybacks, dividend growth, and M&A deals.

The growth of net debt among the S&P 500 constituents has hit levels not seen in the past 10 years, rising significantly against EBITDA levels. Thus, corporations’ operational cash flows are not expanding quickly enough to keep pace with their growing debt loads. This type of imbalance in past cycles has led companies to cut back on spending and hiring.

While consumers have deleveraged since the 2008 housing crisis, corporations have taken advantage of the low rates and subsequent cheap financing. If the Federal Reserve begins to raise rates or economic growth continues to slow, corporations could struggle to cover interest payments on their outstanding debt, which would likely translate to subpar returns for both equity and debt investors.