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Credit Risk in Focus Amid Late Stages of the Business Cycle

Once July begins, the current U.S. economic expansion that began in June 2009 and this month celebrates its 10th anniversary will become the longest on record.

While it may be cause for celebration in some circles, domestic growth during the second quarter is expected to slow from the 3.1% annualized pace in the first quarter. Manufacturing activity based on purchasing managers reports, often a leading indicator for the economy and even stock market performance, have slide to multi-year lows. (See BCJ Financial Group’s recent Monthly Economic Update for further details.)

The current cycle will eclipse that of the 1991-2001 cycle. Economic expansions and contractions have been tracked going back since 1854. Entering this year, there was general agreement that this business cycle, accompanied by a significant increase in business and corporate credit, was in its late stages.

“Selected indicators of corporate fundamentals and financial risk taking point to late-cycle dynamics in the United States…, partly reflecting the longest economic expansion in US history,” the International Monetary Fund said in its annual Global Financial Stability Report published this past April.

“Corporate debt is skewed toward lower-rated issuers, and leverage—often a precursor of economic downturns or financial crises—is close to cycle highs across most credit ratings buckets,” the IMF said.1

From the period between the fourth quarter of 2010 and the third quarter of 2018, just after the deleveraging from the Great Recession, U.S. non-financial businesses added $5 trillion to their overall debt, with non-financial corporations accounting for $3.5 trillion of that total, according to Deloitte.

Since the first quarter of 2011 through the third quarter of 2018, outstanding debt among non-financial corporations rose by an average of 5.6% each quarter, on a year-over-year basis.

“At 46.4% of GDP in Q3 2018, non-financial corporations are carrying more debt today by this measure than they were just prior to the Great Recession,” Deloitte’s Akrur Barua and Patricia Buckley, write in an April 2019 Issues by the Numbers article.2

Even though the Federal Reserve began raising interest rates in December 2015, taking the key federal funds rate from a range of 0.00% to 0.25% to a range of 2.25% to 2.50% as of December 2018, companies have still been able to raise debt with ease. By historical standards, current interest rates following the Great Recession have been quite low, allowing companies to use debt for capital investment, fund acquisitions and even buy back debt. Declining risk premiums for corporate bonds above safe government debt, partly fueled by yield hungry investors, have helped keep borrowing costs low, too.

While rates and available terms to raise debt have been favorable, key financial ratios have deteriorated, indicating that some companies haven’t taken advantage of economic or earnings growth to improve their overall debt profile. Among the top 1,000 non-financial companies by market value, the ratio of net debt to EBIDTA, or earnings before interest, depreciation, taxes and amortization, has risen by 0.5 percentage points, compared to past expansions. Interest coverage ratios, a company’s ability to pay back debt, has also declined.

That contrasts with the two most recent economic recoveries, which Deloitte’s research examined from the 1992-2000 and 2002-2007 periods, when both ratios improved. “The implication is clear. Although corporate debt levels went up in all three of the latest economic recoveries, corporations’ ability to repay debt, unlike in the previous two recoveries, has likely declined in the current recovery,” the Deloitte authors say.

The prevalence of private equity and leveraged buyouts in the current business cycle has also had an impact on issuers’ credit profile. In late May, Moody’s Investors Service said that the number of first-time issuers in North America rated B3 ─ the lowest “high credit risk” notch just above that of C-rated debt or “very high credit risk ─ reached a record high.

The proportion of new issuers rated B3 rose to 44% in 2018, compared to 22% in 2007. About 90% of the current B3 population is owned by private equity, typically from a leveraged buyout, among the most likely reason for an initial B3 rating.

These companies’ loan agreements and bond indentures do contain more flexible credit protections than in the past, allowing them to postpone or avoid default. Yet, many of these issuers could see their ratings downgraded to Caa1 (equivalent to triple-C) or below when equity values contract, credit conditions tighten or the economy turns.

“While the profiles of companies rated B3 vary widely, these issuers frequently have fragile business models and a high degree of financial risk, including excessive debt,” Christina Padgett, a Moody’s senior vice president, said in a release. “Companies with narrow product lines, a limited geographic footprint or that are vulnerable to obsolescence often fit into this category, particularly if they are owned by private equity and are highly leveraged.”3


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  1. International Monetary Fund. (2019, April). Global Financial Stability Report: Vulnerabilities in a Maturing Credit Cycle. Retrieved from:
  2. Barua, A. and Buckley, P. (2019, April 15). Rising corporate debt: Should we worry? Issues by the Numbers, April 2019. Deloitte. Retrieved from:
  3. Moody’s Investors Service. (2019, May 29). Research Announcement: Moody’s ─ Number of debt issuers rated B3 swells, heightening vulnerability to the next default cycle [Press Release]. Retrieved from:–PBC_1178428

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