Rising Corporate Leverage and its

Impact on Asset Returns

Sam DeRosa-Farag
June 2016

Increasing Leverage as an Optimal Solution for

Corporates and its Impact on Asset Returns
After 2008, there was an expectation of a rapid decline in leverage.
However, while leverage in the financial sector and the household sector
declined, the corporate sector continued to increase leverage.
Increases in perceived systemic risk and delinquencies led to declining
leverage in the financial and household sectors respectively.
Declining long term rates, inflation and economic growth, lower GDP
volatility and lower corporate default rates encouraged US corporates to
increase leverage.
The resulting return pattern observed since 2000 has shifted the shape of
the security market line into a convex vs. the more conventional upward
sloping line. Unexpectedly, above average risk-assets underperformed
medium risk-assets.
Increasing corporate leverage has resulted in increased return dispersion
with a higher uncertainty of returns.
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Household Sector Debt as a % of GDP

Percent of GDP

120
100
80
60
40
20
0

14%

Source: Federal Reserve, Flow of Funds Table D1 via FRED

Financial Sector Debt as a % of GDP

Percent of GDP

140
120
100
80
60
40
20
0

Source: Federal Reserve, Flow of Funds Table D1 via FRED

US Corporate Debt as % of GDP

Percent of GDP

180
160

Nonfinancial Corporate Debt as % of GDP

153%

140
120
100
80
60

69%

40
20

25%

Source: Federal Reserve, Flow of Funds Table D1 via FRED

Lower GDP Volatility

US and Euro Area GDP Volatility
8
7
6
5

USA: Average
Q3 1950 - Q3 1985

USA: Average
Q4 1985 - Q4 2015
2.17
Euro Area: Average
Q4 1998 - Q4 2015
2.14

4
3
2
1
0

USA

Euro Area

16-Quarter Standard Deviation of Real GDP, % Change from Preceding Period, Quarterly, Seasonally Adjusted Annual Rate
Source: BEA and Eurostat

US Inflation Since 1880

10%

10-Year Annualized US CPI

8%
6%
4%
2%
0%
-2%
-4%
-6%

Source: Robert Schiller

Long-Term Rates: 10-Year Treasury Yield

18%
16%
14%
12%
10%
8%
6%
4%
2%
0%

Source: Robert Schiller

G4 Nonfinancial Corporate Net Debt

and Equity Issuance

Note: $tr per quarter, G4 includes the US, the UK, the Euro area and Japan. Last observation as of Q4 2015.
Source: ECB, BOJ, BOE, Federal Reserve flow of funds

Barclays US HY Index Quality Breakdown

Note: Market Values.

Source: Barclays Research

10

Growing Share of Speculative Grade

Issuers among US Corporates
60%
55%
50%
45%
40%
35%
30%
25%
20%

1981 1984 1985 1987 1989 1991 1994 1997 1998 2000 2001 2003 2005 2007 2009 2011 2015

*Total US rated corporate issuers = 3251 corporations . 1785 are sub-investment grade. Only 3 issuers are AAA
Source: S&P

11

Downgrade vs. Upgrades

Downgrades have outpaced upgrades by a ratio of 2-to-1; S&P domestic issuers
upgrades and downgrades

Source: Standard & Poors; 2013 data as of Q2 2013, JP Morgan

12

US Investment Grade Net Leverage

Upward trend in US IG net leverage

Source: J.P. Morgan

13

Risk/Return Comparison 1988-1999

20%
S&P

18%
16%

Annualized Return

14%
12%
BB

10%

Barclays Agg

8%

HY
CCC

US 7-10Yr

6%

GSCI

3Mo TBill

4%
2%
0%

MSCI Japan

0%

5%

10%

15%

20%

Annualized Standard Deviation of Returns

25%

30%

Annualized returns and standard deviations based on monthly returns over stated period for following indices: 1/29/1988 12/31/1999
The Trend line is fitted by the equation Y=ax + bX2 +c to the data represented by the blue diamonds
Source: 3-Month T-Bill = GB3 Govt (Bloomberg) Index, US Treasuries = Barclays US Treasury Index, Barclays Agg = Barclays US Aggregate Index, HY = Barclays US Corporate
High Yield Total Return Index, S&P = S&P 500 Total Return Index (Bloomberg: SPXT), GSCI = S&P GSCI (Commodities) Total Return Index, BB = Barclays U.S. High Yield Quality
Distribution Ba Index, B = Barclays U.S. High Yield Quality Distribution B Index, CCC = Barclays U.S. High Yield Quality Distribution Caa Index, MSCI Japan = MSCI Japan Total
Net Return Index (NDDUJN)

14

Risk/Return Comparison 2000-2016

14%
REIT

12%

PE

Annualized Return

10%

EMBI
BB

8%
UST 7-10 Yr
Barclays Agg. TIPS

6%

US MBS

4%
2%

S&P Energy

HY
B
US CMBS

CCC
S&P 500

CS LL Index

MSCI EM

S&P Euro 350

1-3 Month T-Bill

5%

S&P Tech
GSCI

MSCI Japan
0%

S&P Financial

CS Leveraged Equity

0%
-2%

S&P Industrial

10%

15%

20%

25%

30%

Annualized Standard Deviation of Returns

Annualized returns and standard deviations based on monthly returns for following indices from 1/31/2000 - 5/31/2016 (except PE)
Data: PE = Cambridge Associates U.S. Private Equity Index (Quarterly, Q1 2000-Q4 2015); 1-3 Month T-Bill = Barclays 1-3 M T-Bill Index; US MBS = Barclays Aggregate Index:
MBS component; Barclays Agg = Barclays US Aggregate Index; CS LL = Credit Suisse Leveraged Loans Index; TIPS = Barclays TIPS Index; UST 7-10 Yr = Barclays 7-10 Yr Treasury
Index; BB = Total Return BB component of Credit Suisse HY Index; US CMBS = Barclays Aggregate: CMBS (ERISA Eligigble) component; B = Total Return B component of CS HY
Index; HY = Credit Suisse HY Index Total Return; EMBI = JP Morgan EMBI Index Total Return; CCC = CS HY Index: Total Return CCC Component; S&P = S&P 500 Total Return
Index, S&P Euro 350 = S&P Euro 350 Index: Total Gross Return; REIT = Dow Jones Equity REIT Total Return Index; GSCI = S&P GSCI (Commodities) Total Return Index
Trend line fitted by the equation Y=ax+bx2+c to the data represented by green diamonds. Straight line between single-B and CCC HY bonds

15

S&P Historical Bull And Bear Market Returns

1932-2008

Source: Bloomberg

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