Since the financial crisis, the total value of debt owed and issued by US corporations has ballooned. Bingeing on low-interest rates, companies have borrowed heavily to finance acquisitions, buybacks, and dividends with few, if any repercussions.
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US corporate debt issuance surpassed $1 trillion for the third year running in 2017. Gross issuance of investment grade debt rose from $792 billion in 2016 to just under $850 billion for 2018. Meanwhile, gross issuance of high yield debt lept 17% from $227 billion to $266 billion.
Data from the Wall Street Journal also shows that the value of leveraged loans issued by companies jumped 50% to $504 billion year-on-year while collateralized loan obligation gross issuance increased 62% to $117 billion.
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And even though it was a record year for debt issuance, the US speculative default rate remained depressed at 3.3%, down from 5.4% at the beginning of the year.
The question is, whether or not defaults will remain low following the introduction of President Trump's new tax regime. Under the new tax plan, companies' interest deductibility is limited to 30% of EBITDA until 2021. After that, the limitation of the deduction would apply to 30% of EBIT.
Corporate Tax Rate Changes To Bring About Defaults?
Based on a sample of 575 leveraged loan and high-yield issuers, credit rating agency Fitch estimates that 37% of the issuers will lose a portion of their interest deductions under the EBITDA definition, 27% would be unable to deduct 20% or more of their interest and 10% would be unable to deduct 50% or more of their interest. When the limitation of interest deduction is based on EBIT, 64% of the sample will lose a portion of their interest deduction.
This would have a substantial impact many high-yield, highly leveraged companies. As Fitch explains:
"A simplified analysis shows that a 5.0x levered issuer with a cost of debt of 6% would realize tax savings due to the corporate tax rate dropping to 21% from 35%. However, the impact turns negative at higher leveraged levels. Assuming a 7.0x levered issuer with a cost of debt of 8%, tax payments would increase and could result in tighter liquidity for smaller companies."
The Wall Street Journal points out Congress’s Joint Committee on Taxation estimates the initial measure would raise about $171 billion in tax revenues over ten years, with the 2021 EBIT measure taking effect in 2022 would raise about $307 billion over ten years.
But what about corporate America? Will the bill result in a wave of bankruptcies as companies struggle to meet their new tax obligations? Possibly, although there are other factors to consider here. The new tax bill sharply reduces the corporate tax rate, to 21% from the current 35%, which cushions the blow and with interest rates heading higher, companies will be facing higher costs no matter what changes are made to the tax code.
With this being the case, it's no surprise there's speculation the new tax regime could actually cause companies to curtail their borrowing binge and even start to reduce debt to cut costs and remain solvent.