the $ 10.6 trillion US corporate debt markets are at an inflection point. Last year’s unrest is in the rearview mirror, and companies are stepping up all the shareholder-friendly activities they were unable to do during the pandemic – and looking to finance some of it with debt.
Why is this important: The economy is built on a credit foundation – and what happens next will determine when and how bad the next cycle of default is.
Catch up quickly: Government programs helped businesses come out of the chasm last year. The Federal Reserve’s liquidity injections kept the debt market open for businesses, and fiscal policy provided money for consumers to keep buying things.
The big picture: On average, the debt ratios of American companies and their ability to pay interest are even better today than they were before the pandemic, estimates S&P Global Market Intelligence.
- Meanwhile, high yield, investment grade bond indices are at or near record yields, which means it’s never been cheaper for companies to borrow money. .
The impact: This led to the recording of new debt investments.
- “Debt has become more affordable. As a result, all other things being equal, you push companies into more debt,” Scott Ruesterholz, fixed income portfolio manager at Insight Investment, told Axios.
- The US high yield and leveraged loan markets are “on track to set new annual gross supply records,” Goldman Sachs analysts wrote last week. And in the market for quality investments, Goldman predicts that 2021 will rank as the second busiest year in the post-financial crisis era – behind 2020.
Over the past year, companies have left many of these debt products remain on their balance sheets as a buffer of safety. But that is starting to change.
For example: Oracle chose to sacrifice its credit ratings to accumulate $ 15 billion in debt last spring to fund share buybacks. Moody’s now ranks Oracle’s debt at the lower end of investment grade status.
- And with high efficiency, Pilot Travel Centers is in the process of debt sale which will provide billions in cash to redeem the preferred stock held by its wealthy owners.
In the future, some investors expect a continuous increase in this style of corporate behavior: going into debt to finance things like share buybacks and dividends, or highly leveraged M&A deals.
Threat level: The “bad” scenario is that too many companies take advantage of cheap capital to fund aggressive financial engineering that puts them in too much debt.
- This sets up a large market correction or pushes forward a deeper default cycle, resulting in losses for investors like mutual funds who buy debt.
Some credit managers believes that safeguards remain in place to keep more aggressive debt transactions isolated from a small segment of companies – rather than creating systemic market-wide concern.
- On the one hand, stock valuations are high enough to cap mergers and acquisitions, and even debt-financed stock buybacks, says Steven Boothe, bond portfolio manager at T. Rowe Price.
- And the management teams remain in defense after the scare of a lifetime last year. “The dark days of March and April of last year are still very fresh on the minds of CEOs and boards. I think we need to get further away from this event before most start to really be. aggressive, ”says High Yield Specialist Will Smith. portfolio manager at AllianceBernstein.
- A new era of antitrust enforcement, led by Biden appointments known as critics of big tech – and big things – is also likely to dampen ambitions for major transformative mergers and acquisitions, Boothe adds.
The bottom line: Companies have used widely open capital markets to push back deadlines that were due to expire over the next several years, so the risk of impending default is extremely low.
- “The question is, are we going to put something up for three to four years down the road?” Roberta Goss, co-head of the bank lending platform and CLO at Pretium, explains.