Zandi: Corporate debt load is worrisome, but not systemic
The rising tide of speculative-grade corporate debt is potentially a new fault line in the hopes for economic recovery from the pandemic crisis, said economist Mark Zandi.
But leveraged loans and collateralized loan obligations do not represent a systemic threat to the global economy or to the U.S. banking system, as some highly charged reports have suggested, he added.
"Some of the concerns that are being expressed most recently about this market are overdone," said Zandi, in an online keynote address for the Information Management Network’s annual 2020 investors conference for leveraged loans and CLOs (an event moved to a virtual setting this year due to COVID-19 concerns). "But this is not existential in any way, in my view, certainly not to the banking system" nor to the economy.
Zandi was addressing the growing worries about the systemic impact of an estimated $2.4 trillion to $2.8 trillion in outstanding speculative-grade corporate debt - much of it in the form of syndicated leveraged loans sold into securitized portfolios (CLOs) that include U.S. and international banks as investors in the triple-A rated tranches of the structured-finance vehicles.
Zandi did not outright dismiss the alarms that have risen over falling revenues and a wave of bankruptcies from firms increasingly strapped to service heavy debt loads of about six or seven times earnings in the rated-loan universe. Zandi noted that year-over-year growth in leveraged loans held in CLOs grew 10.5%, and "over the past three years, average annual growth was 16.1%," said Zandi, who also shared figures showing that non-financial corporate debt has risen to nearly 90% of GDP.
“There was a CEO of a major bank who once told me…that if something in the banking system, in the financial system, is growing like a weed, then there’s a good chance it's a weed.”
But "the Fed's got its foot on the accelerator and prospects are...[that] interest rates remain low for a significant period of time," he said. "It's hard to imagine that this becomes existential to the economy, but certainly something we need to watch and it will be a potential weight on economic growth."
The latter point summed up Zandi's main concern, in that high levels of corporate debt that limit the capital flexibility for firms - and in turn extend the post-COVID economic recovery into a years-long "slog" despite the brevity of the three-month U.S. recession this spring (the shortest on record).
The projected recovery for the U.S. is economy is already "predicated on two key assumptions – that there won’t be a serious second wave and policy makers will continue to be aggressive," he said. Also key is the development and widespread distribution of a COVID-19 vaccine and therapy, if and when available.
Even given those factors, the recovery is likely to be sluggish with continued high unemployment rates, weighed down by low consumer confidence and tepid business investment.
Zandi also cmmented on November's presidential election, which the Moody's Analytics noted electoral model last fall projected would be a landslide re-election for President Trump. But the model, updated under the current economic picture, "now has flipped," he said. "Biden wins."
If the model proves correct (which it has for all elections dating to 1980, with the exception of 2016) and presumptive Democratic nominee and former vice president Joseph Biden takes office in 2021, Zandi believes major changes would be afoot: more open policies for global economic development, foreign investment, immigration and trade, but fewer tariffs. Zandi also expects the expiration of temporary Trump-era tax breaks on higher incomes, especially with a fully Democratic-controlled Congress, plus a return to climate-change focused energy policies.
Zandi spoke only briefly on regulatory policy, but he expects a Biden administration would "reimpose" many of the regulatory controls on the fossil fuel and financial industry that Trump overturned or allowed to lapse.