SocGen’s Andrew Lapthorne believes that weak corporate balance sheets are the fact and the cash on the sidelines is the myth.
In a report published today, Lapthorne highlighted the high level of inequality that’s affecting balance sheets within the US. Specifically, the SocGen analyst notes “US corporate leverage is abnormally high for this stage in the cycle, and a handful of cash-rich mega caps are masking significant problems elsewhere.”
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While the headlines are dominated by Apple’s record cash balance, at the other end of the spectrum, many other smaller firms are struggling to meet their debt obligations. If you strip out the most significant companies, interest coverage for the smallest 50% of US companies “is near record lows, at a time when interest costs are extremely depressed and when profits are at peak.”
This trend is concerning, especially because the Fed is starting to tighten monetary policy. If there are still a substantial amount of firms out there with weak balance sheets after nearly a decade of rock-bottom rates.
Weak Corporate Balance Sheets Persist
Lapthorne isn’t the only Wall Street analyst concerned by this trend. The latest issue of Goldman Sachs’ Top Of Mind research booklet notes:
“Unlike households, non-financial corporate credit quality has deteriorated substantially in this cycle. From late 2011 to early 2016, net leverage ratios, a key metric for firms’ creditworthiness, moved steadily higher, peaking at levels last seen in the late 1990s for both IG and HY-rated companies.”
The article, penned by credit strategists Marty Young and Lotfi Karoui goes on to say that the degradation in balance sheet fundamentals has been “the byproduct of unprecedented appetite for active forms of re-leveraging such as debt-funded M&As and share buybacks.” Weak profitability is also blamed for the trend of increasing leverage.
On the other hand, trends in consumer debt are more subdued. Household debt outstanding has contracted in real terms since 2009 as low-interest rates have helped debt service costs as a share of income fall to near all-time lows.
Still, it’s the business sector where worrying trends are brewing. Goldman’s analysts note commercial real estate (CRE) is another problem area:
“CRE prices have grown faster than singlefamily residential home prices, and CRE lending standards have been looser than residential mortgage lending standards for most of the post-crisis period. US bank CRE loan portfolios have grown to over $2tn in total, so a downturn in CRE prices leading to mortgage defaults could put stress on the banking system.”