Dr. Edward Altman and CreditRiskMonitor CEO Jerry Flum on the Looming Corporate Debt Crisis

Debt is a growing problem, both in the U.S. specifically and worldwide.

As the Congressional Budget Office announced earlier this year, U.S. debt held by the public is projected to reach 150% of GDP by 2047. Currently, the $19.9 trillion of U.S. public debt equates to about 107% of GDP, according to the Pew Research Center.

Although the U.S. is in an unenviable first place in gross public debt, debt as a percentage of GDP is on the rise worldwide. For example, at $11.4 trillion, Japan’s debt is 239% of its GDP. The total global public debt stands at $63.1 trillion.

In short, there’s a mammoth debt problem, which was the title of a webinar that CreditRiskMonitor recently hosted on this very topic. Last week CreditRiskMonitor CEO Jerry Flum sat down with Dr. Edward Altman, Max L. Heine professor of finance at New York University’s Stern School of Business, to discuss the coming global debt crisis and the best practices that companies can use to be as prepared as possible for future instability.

Fifty years ago, Altman published the now-famous formula for predicting bankruptcy. The Altman Z-score uses five financial ratios to calculate the likelihood that a business will go bankrupt within two years.

Flum kicked off the webinar with a few charts depicting how debt as a percentage of GDP has grown in the past near-century and how much debt is accumulating all over the world.

“It’s an unprecedented problem,” he said, “It’s never really been seen at this level before, and the riskiest part of it is going to be junk bonds and possibly junk loans.”

(Not So) Benign Indicators

Low interest rates, yields and spreads. High liquidity. Low default rates (and if defaults do occur, high recovery rates). For nearly eight years now, we have been in a benign credit cycle, defined by the preceding characteristics. This, Altman explained, is unprecedented, and we may be in for another crisis.

“It’s almost a paradox,” Altman said. “You’re in a benign situation, everyone says that things are great, let’s take advantage of it, risk on…. You forget about history.”

Another worrying indicator is an all-time high margin debt. Flum displayed a chart that showed the S&P 500 Index and margin debt as a percentage of GDP. As of the end of June 2017, margin debt was at $539.12 billion, or 2.83% of GDP.

“As you can see, not only is every part of our society leveraged up and the investors are leveraged up, even the college kids are leveraged up,” said Flum. “I don’t know who’s left.”

What Should Companies Do?

Altman and Flum had several suggestions for those who want to be as prepared as possible in these uncertain times (undoubtedly, if you’re reading this, that includes you). First of all, “don’t let down on your credit culture,” Altman advised. “It’s very easy to push it all aside and go for market share and increase your revenues to the extent that you don’t look at the debt ratios.”

One audience question that came in was the following: “Is the issue with debt limited to publicly held companies? If private companies are also at risk, is there a difference in how you would monitor those solutions or those situations?”

The short answers are no and yes. Privately held companies are also at risk, but since their financial information is usually unavailable (unlike public companies), credit analysts have to look at trade receivables or trade payables instead.

Flum and Altman recommend paying special attention to public companies, as they can (and do) lever up more than private companies. Be alert for when junk bond companies’ stocks begin to fall and for the next big market correction, for it could happen faster than one would expect, the experts warned.

Notable Quotables

“If you combine all the junk bonds in the world, we’re talking about $2.5–$3 trillion, the highest it’s ever been.” — Dr. Edward Altman

“Historically, benign [credit] cycles … last at most seven years. Four to seven years has been the cycle. Now we’re in unprecedented territory in respect to this [eight-year-long] benign cycle.” — Dr. Edward Altman

“Somebody owns that debt. In other words, it’s in the portfolios, the pension plans, the 401Ks, the mutual funds of all of America and all of the world. So, if in fact interest rates were to go up and defaults were to go up, the wealth of everybody is going to go down.” — Jerry Flum

“I don’t think [a crisis] is going to happen tomorrow, but the problem is, if we let our guard down, then tomorrow comes very quickly.” — Dr. Edward Altman

“We have almost $11 trillion of negative sovereign debt that has been issued, which has never happened in the history of mankind before. [This is] somebody giving a government a dollar to get back 98 cents basically.” — Jerry Flum

A full replay of the webinar can be watched here.

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