The zero interest rate environment created by the Federal Reserve spurred the issuance of trillions of dollars worth of corporate debt. With cheap money being readily available, it was no surprise that businesses took advantage of it in order to fund their operations and buy back their stock. Given the tax advantages afforded to debt issuance, most companies prefer to fund themselves through debt rather than equity. But much of that debt has been of low quality, with the amount of low-grade corporate debt higher than it has ever been. When that debt bubble finally collapses it could take the economy down with it.
The amount of outstanding BBB-rated debt is higher now than it was in 2008. In the United States 58% of all investment-grade debt is BBB-rated, versus 48% in 2008. In Europe 58% of investment-grade debt is BBB-rated too, up from 34% in 2008. BBB-ratings or equivalent are the lowest level of investment-grade debt, with BBB+ being the highest BBB rating, followed by BBB and then BBB-. Below that, bonds with lower ratings (BB, B, CCC, etc.) are considered junk bonds. Among the largest issuers of BBB-rated debt today are major household names such as AT&T – Time Warner, Verizon, Anheuser-Busch InBev, CVS, GE, GM, Ford, Capital One, and Kraft Heinz.
The danger to these BBB-rated companies is that as interest rates rise the cost of financing their debt will increase. That could put pressure on the companies, leading them to devote more money to debt service rather than to productive endeavors within the business. In the event that they are judged likely to have difficulty in servicing their debt, they could receive a downgrade to junk status.
The danger of investment-grade debt being downgraded is that it could trigger a massive amount of sales. Various financial institutions that hold this BBB-rated debt and that are regulatorily, statutorily, or contractually obligated to hold investment-grade debt may be forced to sell off any debt that falls from BBB to BB. With other institutions in similar situations being unable to buy that debt, the result could be a massive fire sale of debt, with few buyers. That could severely upend financial markets, freeze debt markets, and spur another financial crisis.
