GE also got a helping hand from Federal Reserve officials, who decided to pause rate increases. That amounted to a stay of execution for the U.S.’s most-indebted companies, which were at the center of much of the market volatility last December.
But it isn’t yet clear that U.S. corporate borrowers have learned lasting lessons from last year’s near-death experience. In fact, all but the most-indebted ones seem all too willing to borrow even more—which could come back to bite them if a recession arrives earlier than expected.
“Management teams don’t want to delever until they’re forced to do it,” says Matt Minnetian, director of U.S. investment-grade credit at AllianceBernstein. And “there’s a lot less pressure now that we’ve seen equities rally.”
(LOW), for example, borrowed $3 billion earlier this month. The home-improvement retailer said it would use about $1 billion of that to refinance short-term debt. That left $2 billion for other purposes, which ostensibly include the larger share-buyback program it announced in December.
But there is also some evidence that companies have become more cautious about adding debt to their balance sheets. U.S. corporate bond issuance is down about 5% from this time last year, according to Bloomberg data. And fund managers surveyed by Bank of America Merrill Lynch still want companies to use cash to reduce debt.
In its latest monthly poll, the bank found that 43% of fund managers want companies to pay down debt with extra cash, more than the 33% who wanted capital improvements. Only 16% preferred more share buybacks or dividends. Two years ago, more than half of fund managers surveyed said they wanted more capex.
“The age of balance sheet repair is here,” the bank’s strategists wrote in an April 22 note. “After years of transferring value from bondholders to shareholders, companies may now be forced to instead defend their balance sheets at the expense of shareholders.”
That would be a big change. Since 2013, about half of share buybacks and dividends have been financed with debt, according to the bank. And share buybacks are responsible for nearly a third of the
earnings-per-share growth since 2015.
Yet the Fed’s pause in rate increases may delay the end of the leverage party, and fund managers’ desire for debt reduction has faded along with memories of the December selloff.
First, short-term borrowing costs are higher than they were a couple of years ago, even if the Fed isn’t raising rates now. And the bank’s latest poll shows that shareholders haven’t completely forgotten the December selloff.
Second, an unusually large share of bonds in the market now come from companies rated one to three levels above junk, known as the BBBs. Those companies can’t add much additional debt without risking a downgrade to junk status, BofA Merrill Lynch says—and that would significantly push up their cost of borrowing.
What’s more, investors and companies alike fear the economic expansion could be in its later stages. It has been a decade since the last downturn. And last month the yield curve briefly inverted, which is widely seen as a recession signal.
Because companies are likely to reduce debt levels, BofA Merrill Lynch says, shareholders should temper their expectations for debt-fueled profit growth and dividends and buybacks—though any associated decline in stock prices is likely to be short-lived.
Write to Alexandra Scaggs at firstname.lastname@example.org