After tapping the bond market at a record-shattering pace in recent months, Corporate America is more indebted today than ever before.
And while much of that fresh cash -- more than $1.6 trillion in total -- helped scores of companies stay afloat during the pandemic lockdown, it now threatens to curb an economic recovery that was already showing signs of sputtering. Many companies will have to divert even more cash to repaying these obligations at the same time that their profits sink, leaving them with less to spend on expanding payrolls or upgrading facilities in months ahead.
The over-leveraging of America’s corporate sector is not a brand-new development, of course. It’s been building for more than a decade, ever since the last crisis -- the housing-market meltdown -- prompted the Federal Reserve to pump unprecedented amounts of cash into the economy, a policy tool that it has taken to new heights during the pandemic as it has supported corporate credit markets.
But in a sign of just how pronounced the borrowing overhang has become, the average junk-rated company had debt levels relative to earnings that were so high in the middle of the year, according to a new analysis by Bloomberg Intelligence, that they almost would have tripped do-not-touch alerts from banking regulators a few years ago. Those warnings back then only applied to a handful of borrowers. Had regulators not opted to drop these warnings, they could today apply to far more.
“An overburdened corporate sector is likely to grow less rapidly and that could slow the whole recovery down,” said Kathy Jones, chief fixed-income strategist for Charles Schwab Corp.
A slower recovery could have wide-reaching implications in financial markets. Many securities prices reflect investors’ expectation that profits will normalize next year, when in fact it could take at least two or three years, said Lale Topcuoglu, senior fund manager and head of credit at J O Hambro Capital Management in New York. She sees many junk bonds as being overpriced.
“It just seems absolutely incredible how much people are closing their eyes and buying,” Topcuoglu said.
Companies have seen their debt burdens grow in recent months as their earnings have plunged in the pandemic. That pain is expected to increase through the rest of 2020 as sales continue to deteriorate compared with the prior year, even if borrowing levels stay the same.
Corporations have also been borrowing heavily as the Fed has slashed short-term interest rates to near zero and supported credit markets through, for example, buying company bonds. Lower rates have spurred investors to buy higher-yielding, riskier securities, which has allowed even junk-rated firms to borrow more to tide them over during the crisis. High-grade issuers have already sold more bonds in 2020 than any other full year in history. Junk corporations have surpassed 2019’s total already.
Much of the debt sold in recent months has refinanced maturing borrowings at lower rates, and some companies are holding on to the money they raised as cash and may end up not spending it. In general, the fact that companies managed to stay afloat during the pandemic is a good thing compared with the alternative of even more corporations having gone bankrupt. But not all companies can access that credit -- smaller borrowers, for example, are often getting shut out.
And there will probably be a hangover. Many companies were groaning under their debt loads even before the Covid-19 pandemic, and now will have to work harder to cut borrowings as earnings remain depressed. Even if companies are hanging on to the money they borrowed, they must still pay interest on it, and could eventually use the cash if the pandemic drags on.
The ratio of total debt to a measure of earnings known as Ebitda for investment-grade companies was 3.53 in the second quarter for the Bloomberg Barclays U.S. Corporate high-grade index, according to an analysis from Bloomberg Intelligence. That’s the highest in data going back to 1998, and is up from 3.42 in the first three months of the year, when the impact of the pandemic was only just beginning to show up in earnings. It compares with a 20-year average of 2.65.
For high yield, that leverage ratio stood at a record 5.42 at the end of June, up from 4.93 at the end of March and 4.44 at the end of 2019. Avis Budget Group Inc., the car rental company, had debt equal to 27 times earnings as of June 30, up from five times at the end of March, as it burned cash in the second quarter, although that figure could improve later this year as its earnings start to rebound. In 2016, banking regulators pushed back against leveraged buyouts that left companies with ratios above six.