The US corporate COVID cash hoard is mostly gone. Is it time to worry?
By Joy Wiltermuth
Corporate debt deluge comes at a good time as recession fears rise
Cash was king at the start of the COVID crisis. This is no longer the case.
Corporate America burned through piles of cash hoarded at the start of the pandemic, cash largely hoarded on a record borrowing spree in the bond market.
The reversal in the pandemic liquidity trend, especially in highly rated companies, can be attributed to a deluge of share buyback programs from 2021, a decline in debt issuance as interest rates interest rise and the bite of high inflation.
Goldman Sachs credit researchers have warned that liquidity positions “have weakened significantly” and net margins have begun to decline, which will shed light on how easily companies can continue to pay interest on their outstanding debt in the coming months.
Like households, it is not necessarily a decline in income that immediately hurts a business, particularly if it has cash, but the inability to meet ongoing debt repayments that can lead to default. of payment.
In this regard, high-quality companies have depleted a key source of liquidity: their cash-to-asset ratio, which has fallen to around 3.5% this year from a pandemic high of 5.5% (see chart), even though earnings to debt ratio have remained high.
“While interest coverage ratios don’t necessarily show cracks yet, they will be an important metric to watch going forward,” Lotfi Karoui’s credit research team at Goldman wrote in a client note. weekly.
Not only has new debt issuance slowed from its annual high of $1.4 trillion in 2021 as the Federal Reserve raised its benchmark rate, but well-rated companies must eventually replace low-coupon pandemic bonds issued. by new debts.
About $600 billion of investment-grade U.S. corporate bonds mature next year, followed by another $690 billion in 2024 and about $750 billion in 2025, according to Goldman research.
Given Fed Chairman Jerome Powell’s vow to curb inflation, corporate borrowing is likely to have higher costs. The ICE BofA US Corporate Index’s return was just below 5% this week, a roughly 13-year high, and up from an all-time low of 1.8% for the index in December 2020. .
Higher rates make it more expensive for businesses to borrow, which can weigh on stock prices. Recession risks also make bond investors worried about being paid too little to lend to companies that could see their profits plummet if the economy crashes.
Underscoring those concerns, a review of second-quarter earnings showed that 240 S&P 500 index companies mentioned “recession,” according to earnings transcripts reviewed by FactSet, the highest since at least 2010.
The S&P 500, Dow Jones Industrial Average and Nasdaq Composite Index posted weekly gains on Friday, ending a 3-week losing streak, but were still down about 11.5% to 23% on the year, according to FactSet.
A big concern for debt and equity investors is whether the Fed goes too far in its fight against inflation, tipping a slowing economy into a recession.
Fed Governor Christopher Waller said on Friday that the Fed may have to raise its benchmark interest rate “well above 4%” if inflation does not show signs of finding a path below l central bank’s 2% target.
Significantly higher benchmark rates have already caused problems this year for total returns on investment-grade U.S. corporate bonds, which fell 15% on the year to August, according to Deutsche Bank research .
The 10-year Treasury yield hit 3.3% on Friday, up for six straight weeks and above a low of 1.6% about a year ago, according to Dow Jones Market Data.
Most individuals gain exposure to corporate bonds through exchange-traded funds. The largest in the United States, the iShares iBoxx $Investment Grade Corporate Bond (LQD) ETF, was down 18.2% on the year through Friday, according to FactSet.
Read:Bad news for stocks: Fed to be surprised how hard rate hikes hit economy, BlackRock says
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