Here’s a gut check for bond investors: corporate America is now more leveraged than ever.
As this year’s corporate bond sales raced past $1 trillion on Wednesday -- marking the fifth consecutive year of trillion-plus issuance -- Morgan Stanley published a report Friday highlighting the growing strains on company balance sheets. The report, which estimated US companies’ collective debt at a record 2.4 times their collective earnings as of June, comes at a time of growing angst in global bond markets
“The investment-grade ‘safe’ part of the market is becoming the most dangerous,” said Ashish Shah, chief investment officer at AllianceBernstein LP. “There are so little returns out there. People are crowding into whatever they can.”
The debt metric, which doesn’t include banks and other financial companies, has climbed for five straight quarters as corporate profits decline at the same time companies load up on the increasingly cheap borrowings, Morgan Stanley analysts led by Adam Richmond wrote in a note to clients. In 2010, when the U.S. economy started recovering from the longest recession since the Great Depression, the ratio fell to 1.7 times.
But what has the analysts uneasy isn’t just the speed at which leverage is climbing, but that it’s happening while the economy continues to grow.
“Leverage tends to rise most in a recession -- so the fact that it is this high in a ‘healthy economy’ is even more concerning,” the analysts wrote. In other words, they said, “mistakes are both more likely and more costly.”
The analysts’ assessment wasn’t totally worrisome. Years of near-zero interest rates have made it a lot easier to service those debt loads. The typical company’s annual earnings before interest, taxes, depreciation and amortization, known as Ebitda, is still almost 10 times its interest payments, Morgan Stanley’s data shows. Even that number has been declining, though, as earnings slump.
Aggregate cash levels are also still growing, although the pace of growth has slowed, according to the report.
The weakening balance sheets could become more worrisome if investors lose confidence that central banks will keep extending their unprecedented stimulus efforts that have driven yields to record lows. Those concerns flared up the past week, and rates on 30-year Treasuries recorded their biggest two-day selloff in more than a year.
Corporate-bond issuance this year is on pace to exceed last year’s record $1.3 trillion, data compiled by Bloomberg show. That would push sales during the past five years to more than $6 trillion. Companies that sold dollar bonds this week included Home Depot Inc., Cox Communications Inc. and TJX Cos.
Total debt at companies grew steadily at about 10 percent year-on-year since 2009 and accelerated to 16 percent year-on-year at the end of 2015. As that happened, Ebitda fell 4 percent for twelve months through the end of 2015, according to the report.
Debt loads are swelling across most all industries, the analysts said. But it’s been most pronounced among energy and healthcare companies. Companies have also borrowed to buyback stock rather than investing, a factor that contributed to weak productivity in the U.S. economy, and that does not “bode well for earnings,” the analysts wrote.