With interest rates on bank deposits not lucrative enough, while you may be mulling to invest in corporate bonds, a latest McKinsey report says that nearly 25% of the corporate bonds are at a high risk of default. In the report, Mckinsey notes that total debt (including household, nonfinancial corporate, and government debt) has grown by three-quarters since the financial crisis, from $97 trillion in 2007 to $169 trillion in the first half of 2017 in constant exchange rate terms. “Government debt accounts for 43 percent of this increase; less noticed has been growth in nonfinancial corporate debt, which is nearly as big,” Mckinsey said.
According to the firm, nearly 20 percent of total global corporate debt is in the form of bonds, nearly double the share in 2007. “The global value of corporate bonds outstanding has increased 2.7 times since 2007 to $11.7 trillion, doubling as a share of GDP,” noted the global firm. While the long-awaited deepening of corporate bond markets and the diversification of corporate financing is good for the health of global financial markets, there are risks. Non-investment-grade bonds have almost quadrupled in size over the past decade, reaching $1.7 trillion in advanced companies, noted the firm.
“Between 2018 and 2022, a record $1.6 trillion to $2.1 trillion of corporate bonds will mature annually. Our analysis shows some of those issuers have fragile finances, and corporate defaults are already above the long-term average,” noted McKinsey. Coming to emerging economies such as India, McKinsey noted that 20 to 25 percent of corporate bonds are at higher risk of default (issued by companies with an interest coverage ratio below 1.5). “In our simulation of a 200-basis-point rise in interest rates, that share could increase to 30 to 40 percent,” McKinsey noted.
In contrast, corporate borrowers in advanced economies are in better financial health, with less than 10 percent of bonds (and below 5 percent in large European countries) issued by companies with weak finances. “However, particular sectors and smaller companies could be vulnerable. In the United States, for instance, 18 percent of the value of bonds outstanding in the energy sector—$104 billion—is at higher risk of default,” said the McKinsey report.