In Stark Warning, IMF Finds Over 20% Of US Corporations At Risk Of Default Should Rates Rise
The IMF then warns that the number of firms with very low interest coverage ratios — a common signal of distress — is already high: currently, firms accounting for 10% of corporate assets appear unable to meet interest expenses out of current earnings:
This figure doubles to 20% of corporate assets when considering firms that have slightly higher earnings cover for interest payments, and rises to 22% under the assumed interest rate rise.
The stark rise in the number of challenged firms has been mostly concentrated in the energy sector, partly as a result of oil price volatility over the past few years. But the proportion of challenged firms has broadened across such other industries as real estate and utilities. Together, these three industries currently account for about half of firms struggling to meet debt service obligations and higher borrowing costs.
As the FT notes, this stark warning warning about potential US risks resulting from a sharp rise in interest rates, came alongside what was otherwise a relatively cheery assessment of the broad state of global financial stability, which the IMF said had been improving since last year. Besides the possibility of US policy mis-steps the IMF said China’s credit boom continued to pose a major risk to the global economy as authorities there struggled to rein in credit growth, repeating what has increasingly become a regular warning from the fund.
The IMF also reiterated a well-known warning about China's financial system, whose assets are more than 3x greater than China's GDP (more on that later), as well as bringing attention to the European bank sector, where “persistently weak profitability is a systemic stability concern."
As for the biggest risk denoted by the IMF, the threat of mass defaults should interest rates spike making debt service impossible for up to 22% of US corporations, perhaps it was this that Gary Cohn explained to Donald Trump ahead of the president's recent interview with the WSJ in which he admitted that he suddenly prefers lower interest costs. That said, it remains to be seen if the "unproductive fiscal expansion" envisioned by the IMF can be avoided.
* * *
Finally, here are two useful panels from the IMF depiting the evolution of corporate leverage and the credit cycle in the US...
... as well as the full visual explanation of linkages between debt service, interest coverage ratios and corporate vulnerability resulting from higher interest rates.