By Mike Dolan
One of the great financial fears of the pandemic may turn out to be another huge boon to the global recovery.
As economies were ordered to shut down last year and companies around the global scrambled to build up cash buffers to help survive periodic lockdowns since, soaring corporate debt levels sowed anxiety about mass bankruptcies and defaults once governments and central banks rolled back supports.
Indeed many firms in the worst-hit sectors may not make it and default rates among the riskiest 'high yield' borrowers in the United States and Europe doubled as the pandemic unfolded last year.
Yet - just like the swell of pent-up household savings in developed economies - most of the precautionary cash raised by companies via bond sales last year has yet to be deployed, even as business activity recovers sharply.
On aggregate global corporate debt net of cash 'barely budged' last year, estimates asset manager Janus Henderson in analysing debts of 900 non-financial companies around the world. With hefty capital expenditure as well as buybacks and dividend increases ahead as a result, that cash splash could supercharge both the economic and stock market bounceback.
"Economic growth is rebounding strongly in most parts of the world. Profits will follow suit. The big question is what will happen to the eye-watering $5.2 trillion of cash sitting on company balance sheets," wrote Janus Henderson portfolio managers Seth Meyer and Tom Ross. "We should not forget that this year’s cash flow will only add to the pile."
The deep dive into companies' financial battle over a year of COVID-19 disruption show total corporate debts soaring 10%, or by $1.3 trillion to a record $13.5 trillion in 2020 - but then virtually no more borrowing in the first half of this year.
Thanks to huge government and central bank supports and floored interest rates - which meant disaster was averted last year for most firms despite a earnings contraction of more than 30% - the vaccine-aided rebound left them swimming in cash.
Slashed dividends, halted stock buybacks and asset sales left brimming cash coffers - which increased by more than a trillion dollars - for debt reduction. An estimated $130 billion was saved in dividend cuts last year, according to hethe Janus Henderson numbers, and U.S. companies alone saved $111 billion.
As a result, only about 40% of the companies in the sample increased their net debts - or debt net of cash. Adjusting for exchange rate movements, global corporate net debt only rose by $36 billion to $8.3 trillion.
Along with ongoing central bank largesse, the numbers and the lack of new borrowing explain why corporate bond yields and spreads over government benchmarks continue to decline - with U.S. investment grade and junk bond spreads falling to their lowest since before the global credit crunch 12 years ago.
Redeeming Fallen Angels
While variations between sectors - such as booming Big Tech or devastated airline or leisure industries - has been greater than between regions, there are signs last year's spike in overall default rates will subside again into 2022.
Janus Henderson sees a global default rate potentially below 1% this year and only slightly higher next.
Credit ratings firm S&P Global reckons the post-pandemic economic boom and improved credit metrics will see U.S. and European junk default rates drop to 4% and 5% by March next year from more than 6% for both at present.
And yet for all the seemingly aligned stars for the economy and even stocks, bond investors appear pretty uncomfortable sitting on what are now pretty expensive assets.
After all, spending roughly half the surplus cash piles this year would see net debt rise by $500-600 billion.
Strategists at the world's biggest asset manager BlackRock claim to be underweight corporate credit as valuations are too 'rich' and prefer to take the risk in equity. Pictet Asset Management's chief strategist Luca Paolini said the firm was underweight riskier bonds such as U.S. high yield.
And Deutsche Bank too told clients that while it's difficult to be too bearish on credit this year, nervousness about central banks tapering support and historically expensive valuations may see debt spreads 'mildly' widening into yearend.
But the overview masks numerous moving parts.
Meyer and Ross reckon the boom in underlying economic demand should offset any modest reduction of central bank supports and the place to look closely at is companies trying to restore their lost investment grade credit rating status.
Pointing out a 100 basis point yield premium between the highest 'junk' rated debt at BB and the lowest investment grades of BBB, they think there's still value in the prospect of redeemed fallen angels - such as Kraft and Netflix, who lost their respective perches during the pandemic. And also rising stars seeking investment grade for the first time, such as automaker Stellantis in January.
Fears about armies of zombie companies emerging from 18 months or more of pandemic supports has been one of the big financial anxieties of the COVID-19. There may be many.
But judging from the state of the corporate debt world overall so far this year at least, thoughts of a corporate apocalypse seem wide of the mark.
