Clock Ticks on Balance Sheet Fiesta
Credit traders are sending an ominous message to U.S. companies: Either stop borrowing so much money or prepare to face some serious consequences.
Investors are now demanding a 61 percent bigger premium over benchmark rates to own top-rated bonds of industrial companies compared with June 2014. Such debt has lost 4.2 percent in the period when stripping out gains from benchmark government rates, with relative yields rising to 1.8 percentage points from 1.1 percent percentage points 16 months ago, Bank of America Merrill Lynch index data show.
Part of this is just saturation in the face of yet another year of record-breaking bond sales. Investment-grade companies have issued more than a trillion dollars of bonds so far in 2015 on top of the $5 trillion in the previous five years, data compiled by Bloomberg show.
But this year’s weakness in credit markets isn’t just a technical blip; it highlights a significant deterioration in corporate balance sheets. After all, what have these companies done with the money they’ve raised? They’ve bought back their own shares and paid dividends to their shareholders. What they haven’t done is use the money to improve their businesses.
It’s getting to the point where even stockholders are tiring of their companies’ repurchasing shares and borrowing money simply because it’s cheap. A Bank of America fund-manager survey last month showed that equity investors are essentially asking corporations to be more conservative with their balance sheets.
Here’s why: Top-rated non-financial companies have increased their median leverage to 2.2 times debt relative to income, compared with 1.6 times in 2011, according to data compiled by JPMorgan Chase.
Bond investors, meanwhile, are still buying top-rated issues, because what else are they going to buy? Central banks from China to Europe are injecting more stimulus into their economies, driving yields lower even as the Federal Reserve debates raising benchmark rates in the U.S. All-in yields of 3.4 percent on U.S. investment-grade company bonds look pretty generous when compared with the 0.5 percent yields on 10-year German government bonds.
“There are some fundamental problems here,” said Lisa Coleman, head of global investment-grade credit at JPMorgan Asset Management. “This is representative of late-cycle growth. We’re more cautious on credit.”
Cracks are starting to form, and they’re getting deeper. This is the first year since 2009 that credit-rating downgrades are significantly outpacing upgrades. Also, the more debt these companies pile on, the more vulnerable they become to a bad blowup that will leave them with extremely bloated balance sheets relative to revenues.
It makes sense that American companies now have to pay more to borrow, and the cost is probably only going to increase. But the lure of easy money appears to blinding them to the warning signs of misfortune, and they ignore them at their peril.
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