In Stark Warning, IMF Finds Over 20% Of US Corporations At Risk Of Default Should Rates Rise

Tyler Durden's picture

While the market has been generally euphoric over Trump's proposed fiscal agenda (even if in recent weeks it increasingly looks its implementation will be indefinitely delayed), one adverse side effect which has largely been ignored by the market is the impact of rising interest rates not only on sovereign debt, but on record corporate debt loads. Conveniently, this was one of the more notably topics covered in the latest Global Financial Stability report released by the IMF on Wednesday.

According to the IMF writes, as corporate leverage has risen, and is now at the highest level since the start either the financial crisis or the dot com bubble, depending on which metric one uses...

... so too has the proportion of income devoted to debt servicing, notwithstanding low benchmark borrowing costs. And while the absolute level of debt servicing as a proportion of income is low relative to what it was during the global financial crisis, the 4 percentage point rise has brought it to its highest level since 2010, which leaves firms vulnerable to tighter borrowing conditions. The average interest coverage ratio—a measure of the ability for current earnings to cover interest expenses— has fallen sharply over the past two years.

Meanwhile the IMF warns that earnings have dropped to less than six times interest expense close to the weakest multiple since the onset of the global financial crisis.

Historically, deterioration of the interest coverage ratio corresponds with eventual widening in credit spreads for risky corporate debt. Here, the IMF is surprised to note that the market pricing of corporate risk has decoupled from the decline in interest coverage ratios, suggesting more mispricing of risk due to central bank intervention:

Declines in the interest coverage ratio have been concentrated mostly in smaller firms, which may have less access to capital market financing than their larger counterparts. Under what the IMF dubs an adverse scenario, an "unproductive fiscal expansion" could lead to a sharp rise in borrowing costs. Such a sharp rise in interest rates amid tepid earnings growth could further compromise the ability of firms to service their debt.

Under this scenario, the combined assets of challenged firms could reach almost $4 trillion, the IMF calculates.

The IMF then warns that the number of firms with very low interest coverage ratios — a common signal of distress — is already high: currently, firms accounting  for 10% of corporate assets appear unable to meet interest expenses out of current earnings:

This figure doubles to 20%  of corporate assets when considering firms that have slightly higher earnings cover for interest payments, and rises to 22% under the assumed interest rate rise.

The stark rise in the number of challenged firms has been mostly concentrated in the energy sector, partly as a result of oil price volatility over the past few years. But the proportion of challenged firms has broadened across such other industries as real estate and utilities. Together, these three industries currently account for about half of firms struggling to meet debt service obligations and higher borrowing costs.

As the FT notes, this stark warning warning about potential US risks resulting from a sharp rise in interest rates, came alongside what was otherwise a relatively cheery assessment of the broad state of global financial stability, which the IMF said had been improving since last year.  Besides the possibility of US policy mis-steps the IMF said China’s credit boom continued to pose a major risk to the global economy as authorities there struggled to rein in credit growth, repeating what has increasingly become a regular warning from the fund.

The IMF also reiterated a well-known warning about China's financial system, whose assets are more than 3x greater than China's GDP (more on that later), as well as bringing attention to the European bank sector, where “persistently weak profitability is a systemic stability concern."

As for the biggest risk denoted by the IMF, the threat of mass defaults should interest rates spike making debt service impossible for up to 22% of US corporations, perhaps it was this that Gary Cohn explained to Donald Trump ahead of the president's recent interview with the WSJ in which he admitted that he suddenly prefers lower interest costs. That said, it remains to be seen if the "unproductive fiscal expansion" envisioned by the IMF can be avoided.

* * *

Finally, here are two useful panels from the IMF depiting the evolution of corporate leverage and the credit cycle in the US...

... as well as the full visual explanation of linkages between debt service, interest coverage ratios and corporate vulnerability resulting from higher interest rates.

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nuubee's picture

Let's go Janet, push the button..

BigFatUglyBubble's picture

Janet just does like homer except hits "p" instead of "y"

https://youtu.be/R_rF4kcqLkI?t=171

Fizzy Head's picture

Bullish on socialising the losses again....

old naughty's picture

put them two in the ring, and let see what the bookmakers say !

Arnold's picture

Let's remember here that the IMF lends to countries that cannot repay under terms they cannot meet.

They aren't very good with numbers.

MalteseFalcon's picture

These "challenged" firms have been living on vapors for 16 years. They have failed the "challenge". SHUT.THEM.DOWN

boattrash's picture

Well that didn't work out as planned. TPTB thought that after all that free monie$, CorpGov would get to pick up at least 60% of them, not 22%...Fuck! Back to the drawing board...

ebworthen's picture

Exactly.  6% Yellen, not this 0.25% B.S.  You can do it Janet!

DavidC's picture

Precisely. This article is bollocks - 'they' WON'T press the button because they're shit scared and WEAK. Rates won't go up.

DavidC

CJgipper's picture

Rates are trapped at the zero bound now.  They won't go up because they can't go up or pensions and stocks would go bust.  They can't allow that, so the rates won't go up.  This is a nightmare scenario story that simply won't ever happen.  Don't fight the fed.

MalteseFalcon's picture

Pension plans can go bust quickly (higher interest rates) or slowly (cash flow runs out).

These are defined benefits plans.

Most defined benefit plans are government employees, which includes the police (you've been warned).

A third scenario is printing money, handing it out and destroying the $.

Destroying the $ quickly, so people will notice.

BTW, this also applies to annuities of any kind.

 

GlassHouse101's picture

Let's just face it, the Fed can't get it up (rates that is).

BullyBearish's picture

death, taxes, bust following boom...

Ballin D's picture

When was the boom for anyone outside of dc/wallstreet?

spastic_colon's picture

the future's so bright I gotta wear depends..............dot plot LOLOLOLOL.......this report is another globalist shot across the bow to any politician that thinks they'll take on the global banking cartel.

Gamma735's picture

Amazon.com?  Rates rise, they have to start charging more.  Customers leave in droves to avoid the higher prices.  Servicing thier debt becomes impossible, company folds. Jeff Bezos will still be rich and Satan will get his soul when he dies.

spastic_colon's picture

on top of that they are now charging tax in many states.......their competetive advantage is waning

ejmoosa's picture

Home Depot?  Rates rise, they have to start charging more.  Customers leave in droves to avoid the higher prices.  Servicing thier debt becomes impossible, company folds. Craig Menear will still be rich and Satan will get his soul when he dies.

Home Depot Debt 2010: 8.7 billion

Home Depot Debt Today: 23 billion

I bet we have dozens of others.

ali-ali-al-qomfri's picture

Sears, grew successfully from “on-line” sales catalog, and continued to grow and build its network  logistics systems to anchor shopping malls across the country.

Amazon, grew successfully from online sales catalog, , and continued to grow and build its network  logistics systems to anchor shopping malls across the country.

 

the moar things change, the moar things stay the lame.

mily's picture

We are so in recession, I wonder what email alias Janet or whomever is running the FED during next meltdown choose, Meet Mr & Mrs Quince?

sheikurbootie's picture

Two words:

Share buyback

Remember even Apple is borrowing BILLIONS to buy their own shares.  Near zero percent interest, why not.  Dumb idea, because when rates do rise they'll be a jam at the exits for selling shares.  Collapse imminent.

NoDebt's picture

All those bought-back shares getting sold back again into a down market so these highly leveraged companies can make their next payroll.  Yummy.

You hit on the reason I think the next significant market downturn may be worse than 2008.  It's not just the debt any more.  It's ironic what they bought with the debt (their own shares, not "plant and equipment", not competitors, not even restructuring costs) is what will FUEL THE MARKET SPIRAL DOWNWARD.  They will be FORCED to do something they don't want to do and at exactly the wrong time to do it.

 

HenryKissingerChurchill's picture

It's ironic what they bought with the debt (their own shares, not "plant and equipment", not competitors, not even restructuring costs) is what will FUEL THE MARKET SPIRAL DOWNWARD.

there have been lots of "Merger & Gutting" going on

spastic_colon's picture

dont forget about the stealth buyers of last resort.....the global central banks.......soon they'll own most equities

NoDebt's picture

Always look to Japan.  They've been doing exactly that (indirectly) for years now via their purchases of ETFs.

 

hooligan2009's picture

if you go here, you can see what the BoJ reports as ETF purchases

http://www.stat-search.boj.or.jp/ssi/cgi-bin/famecgi2?cgi=$nme_a000_en&lstSelection=BS01

i stuffed around with it to get this .csv link

http://www.stat-search.boj.or.jp/ssi/html/nme_R031.21182.20170420021303....

according to that, the ETF purchases are trivial at a total of 2.7 trillion yen since January 2013 or around 25 billion bucks.

this compares to my guesstimate of the value of the Topix of around 5 trillion bucks.

nice chart on the complete failure of libtard socialism in this chart here

http://www.tradingeconomics.com/japan/stock-market

WillyGroper's picture

as soon as they steal what's left of pension funds.

then we can all welcome the nwo one world gummint beast system in full blossom.

hooligan2009's picture

exactly - share buy backs should be illegal - tey only serve to ramp prices so that C-suite execs can milk bonuses from companies that do it

Soul Glow's picture

Funny how the IMF, BIS, and the Fed are never on the same page.  Yellen says the GDP is just "noise" - which is by far and away the most laughable statement ever, the BIS says banks are under capitalized - as if to prepare a "told you so" moment, and the IMF thinks all rates should stay negative forever in an attempt to create a global Weimar.

Be your own bank.  Buy gold.

numapepi's picture

Just the result of wealth transfer from shareholders to the new class executives that run our businesses.

The principle agent dilemma writ large.

Peacefulwarrior's picture

Another post of the obvious with pretty charts. Interest rates go up, the cost of servicing debt goes up in a deflationary environment=circle the drain. If they don't raise rates pensions collapse sooner than later.

NoDebt's picture

Exactly.  Personally, I think they're going to screw the pensioners.  Telling pensioners to f-off is a one-time thing.  Burying the entire debt ponzi scheme and the economy along with it is death to the system and it's entrenched monied interests.  They'll protect their system to the end.

 

Arnold's picture

I suspect my retirement savings 401k increases/return will be measured by Treasury Rates before too long.

Ballin D's picture

I saw a story about how the 'majority' of young people claim to be saving for retirement but only half actually have 401ks. Gave me a good laugh. Of course they aren't putting money in a highly regulated vessel that is set up to be robbed. I have at least 40 years until I'm retiring... No way a 401k will still be around in a recognizable format in that timeframe.

Paul Morphy's picture

Debt Can can only be kicked so far down the road.

Hair trigger time when interest rates rise and/or bond yields begin to rise.

 

Waifer thin accumulated reserves for many corporates, in a scenario where debtors/other current assets can't be realised and where creditors/other current liabilities aren't settled.

nachochan's picture

Because were the IMF which = credible source lol.  They just want us to use there silly SDR fiat when the dollar reserve status fails more globalism ignore the IMF and start using silver.  

zzzz88's picture

even with no rate hike, more and more biz will default. March bankrupcy was already very high. the day is coming!

buzzsaw99's picture

so the small firms go under and the big firms get moar bigger. yellen is pleased.

lester1's picture

That's why we have the almighty PPT based at 33 Liberty Street NYC to buy US Treasuries with unaudited electronic money to keep rates under 3% !!

 

There's a reason why the Fed isn't audited as a matter of "national security" ...

Arnold's picture

For that feeling of Security, Buy Adult Depends.

All others buy physical.

Sonny Brakes's picture

Nevermind, just make sure the band keeps playing.

hooligan2009's picture

i swear these guys have doctorates in the bleeding obvious.

plug in rate rises of 5% and all governments are bankrupt. plug in food price rises of 10% and inflation leaps to 5%.

why not say if pepetual motion is discovered all utilities will go bankrupt, or if a universal cure for disease is discovered all drug companies will go bust or if there is a nuclear war all companies go bankrupt or if all central banking monetary economic theory is proven to be useless (case proven i say) all governments will be declared bankrupt or if H5N1 becomes H8N7 50% of the world's population will die and all business structures will be meaningless.

still, every country's taxpayers pays for the libtard socialist monetary experimenters in the IMF to produce libtard socialst business school papers that state the bleeding obvious about how many different ways the "sky is falling" or the "sky is rising" or "the sky IS THE SKY".

bleh

moorewasthebestbond's picture

Hurry and look!!!!!!!!

 

A financial article on ZH.

MrBoompi's picture

If they can't raise rates high enough to give savers a decent return on basic savings accounts, fuck all of those "companies" who would go out of business.  How goddamn fragile are they anyway?  Why do they even deserve to be in business based on ZIRP alone?  

BSHJ's picture

I had the same thoughts but you had the right words....

Deep Snorkeler's picture

Dear Americans, I Implore You

We must embrace every expedient necessary

to keep this financial bubble going -

no matter how offensive to every historic

principle of sanity, sound money and

financial rectitude.  It is all we have got left.

mo mule's picture

Fuk u, break the system, let it die, kill the breast, then start over, it's easy, close today, have a bank holiday, open next monday. Issue Treasury dollars and send the Fed's back to the BIS with all their debt and tell them they can keep it.  hhaahaha  Fuk the Rothschilds, we don't need to pay you any more.......US Treasury Dollars..