Taking Off Like a Rocket

There are actually two problems with corporate debt. One is that there is too much of it… the other is that a lot of it appears to be going sour.

 

frank-modell-that-s-harvey-beston-he-s-in-junk-bonds-new-yorker-cartoonHarvey had a good time in recent years…well, not so much between mid 2014 and early 2016, but happy days are here again!

Cartoon by Frank Modell

 

As a brief report at Marketwatch last week (widely ignored as far as we are aware) informs us:

 

“Businesses racked up debt in the January-to-March period at the fastest pace in three quarters, according to data released Thursday.

Business debt grew at a blistering 7.9% annual rate in the first quarter, the Federal Reserve said. Business debt has expanded by around 8% in three of the last five quarters. Companies still have substantial cash on the sidelines, as their stockpiles edged down to $1.89 trillion from $1.9 trillion.”

 

(emphasis added)

While Marketwatch told us how much cash companies are holding, for some reason it didn’t deign to tell us how much corporate debt there actually is, in dollars and cents. It would be nice to be able to compare these figures, wouldn’t it?

Here is a chart that shows the sum of commercial loans held by US banks and outstanding US non-financial corporate bonds:

 

1-Corporate debt totalUS non-financial corporate debt… can’t have too much of a good thing! – click to enlarge.

 

Now, as we all know, this debt as been incurred in order to engage in wise capital investment, so it will be very easy to pay it back with future profits…. well, not really, actually. A lot of it appears to have been wasted in decidedly unprofitable investments. This should be no surprise with administered interest rates at zilch for many years.

The rest has been judiciously deployed for financial engineering purposes, such as stock buybacks, m&a activity and even dividend payments. This, we hear, has been quite good for the stock options of many a corporate executive. Who would want to begrudge them that?

 

Charge-Offs and Delinquencies Soar

We are just guessing here….but we believe there must be a few irate bank managers somewhere. Quite possibly they are irate with themselves, for having lent too much money to too many deadbeats. Here is a chart we have frequently shown before: the annual rate of change of the sum of charge-offs and delinquencies in commercial loans (we thank our late friend BC for the inspiration – may he RIP).

Believe it or not, this number is growing at a record fast pace as of Q1 2016 – at 122% y/y it is surpassing even the rate of change peak seen near the trough of the “Great Recession” of 2007 – 2009. And this is happening with the Federal Funds rate target at a measly 0.25-0-50% corridor and the broad money supply (TMS-2) still growing at more than 8% y/y!

 

2-ChargeoffsThe annual rate of change of the sum of delinquencies and charge-offs of commercial loans (black line, lhs), vs. the FF rate (red line, rhs) reaches a new record high. Good thing that corporate debt is “growing at a blistering pace” as well of late, otherwise this might get noticed – click to enlarge.

 

Well, who knows, but maybe buying junk bonds here isn’t the best idea ever. Just a hunch, mind.

 

Conclusion

Corporate debt remains a major Achilles heel of the echo bubble. Color us slightly astonished that so little attention is seemingly paid to it (with the notable exception of Stanley Druckenmiller, who made mention of it at a recent hedge fund conference). In our experience, the things that attract little attention are often worth watching very closely.

 

junkAll aboard the Junk Express! There is no alternative for the discerning fixed income investor!

 

Addendum: Fitch Blurb

We just noticed this small blurb from Fitch in our mail, summarizing the latest developments in junk land:

 

U.S. HY Energy Defaults Tally $13 Billion in May; June TTM Default Rate Approaching 5%

The June trailing 12-month (TTM) U.S. high yield bond default rate is closing inon 5%, reaching 4.7% after another $3 billion of defaults thus far this month, The $46.4 billion of recorded defaults this year is just $2 billion less than the total for the entire 2015.
Through mid-June, energy and metals/mining accounted for 84% of defaults ($38.9 billion). The May energy TTM rate stood at 14.6% following $12.7 billion of sector defaults last month while the E&P rate is at 28.6%. The average high yield bid levels are at 92.9, up from 91.1 last month and from 83.7 in February when crude oil prices were at their low point

 

(emphasis added)

 

Charts by St. Louis Federal Reserve Research

 

 

 

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2 Responses to “The Problem with Corporate Debt”

  • If the debt is collateralised, the winner, once again, will be the banks… No?

    Along with a monetary system that is arithmetically skewed to guarantee asymmetrical purchasing power advantage, the following is not a mystery… No?

    https://www.newscientist.com/article/mg21228354-500-revealed-the-capitalist-network-that-runs-the-world/

  • wmbean:

    My father started his subscription to Fortune Magazine back in 1961 and some time in the summer of 1962 I started reading it out of curiosity. I believe it was a far better publication then than now. Over the next few years one of the stand out criticisms of corporate decision making was the reliance on indebtedness. The rule for good corporate governance was no more that ten percent of book value should ever be on the books as debt and that should always be long term debt. The preferred method of financing expansion and growth was through retained earnings or the issuance of more stock if warranted. Of course when it came to issuing bonds or corporate paper one always established a sinking fund.

    As I recall, Jack Ling made a name for himself by buying up failing corporations. Among those was the military aircraft and missile maker, Chance Vought and it’s air frame maker Tempco. One of the jokes that made the corporate rounds that ling was looking to buy ITT and rename his company “Ting-A-Ling”. Eventually Ling tried to swallow far too much debt and I believe the corporation went into receivership. He wasn’t the first to start the era of conglomerates which were built on acquisitions by exchange of stock, issuance of corporate paper and bonds, and participation by commercial and investment banks issuing debt in the deal. Later we saw the advice that a good company always kept a thirty to forty percent debt level. Sinking funds could be invested in investments that paid better returns than the interest paid out for debt.

    Then came the corporate raiders. Any corporation that was run in a conservative manner tended to have a great deal of cash on hand. So the raiders engage in takeover bids that were often financed by banks so that the corporation could be acquired and then the cash taken out, the company broken up and sold off piecemeal at a profit, and all the little people put out of a job. One may argue that this was a creative destruction but I am not so sure. Hence the way to prevent your corporation from becoming a take over target was to load up the debt to the point where the raider would make little or no profit and might even incur a loss.

    Of course now we see the CEO decide that since growth is stagnant and the only way to improve ROI is through stock buy back and since interest rates are at such low rates, it now makes sense, at least in the short term, to borrow one’s way to wealth.

    This is not the first time that M&A has been used to excess. The 1880’s on were full of such actions. JP Morgan used his wealth and his banks, which were under his control, to finance Acquisitions of companies he thought were worth the risk. But unlike the raiders, his concern was to take a failing enterprise and return it to a sound business state. The people he picked to run these businesses were often the subordinates of the previous owners. He was among the first to start hiring “professional” managers.

    So the question becomes, what have we learned in one hundred and thirty five years of corporation history?

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