The next debt crisis may be corporate
▶▶Companies are borrowing money faster than they’re making it ▶▶Managers face pressure “to cut capital spending and inventories”
Consumers burdened by their large mortgages and maxed-out credit cards laid the groundwork for the last U.S. recession. This time, companies may play that role: Enticed by superlow interest rates, they increased total debt by $2.81 trillion over the past five years, to a record $6.64 trillion. In 2015 liabilities jumped $850 billion, 50 times the increase in cash holdings by S&P Global Ratings’ reckoning. Lagging profits and mounting defaults are other danger signs. Although these financial vulnerabilities aren’t likely to lead to another downturn soon, economists say they point to potential risks for an expansion approaching its seventh birthday. “Companies have been adding to their debt, and their debt has been growing more rapidly than their profits,” says John Lonski, chief economist of Moody’s Capital Markets Research Group. “That imbalance in the past has usually led to problems” once growth begins to flag. Some are concerned that’s already happening, as evidenced by cutbacks in corporate spending and hiring. Case in point: the news that employers expanded payrolls in May at the slowest pace since 2010, in what economists at JPMorgan Chase worry is a sign of increased company caution. Also, April marked the third straight month of falling orders for business equipment. The $62.4 billion figure, which excludes defense and aircraft orders, was the lowest in five years, prompting Neil Dutta of Renaissance Macro Research to label business investment “pathetic.”
The similarities between the prerecession debt binge by consumers and company borrowing today are striking. Like households, corporations are using the money for short-term purposes rather than for preparing for the future. A wide gap exists between a handful of ultrarich companies and the rest of corporate America.
The record $1.84 trillion of cash on company books is heavily concentrated among Apple, Microsoft, Google, and other tech giants, shows a study released in May by S&P analysts Andrew Chang and David Tesher. Companies that don’t have big cash reserves might find it harder to meet debt payments when interest rates rise. Take away the $945 billion the 25 richest companies rated by S&P hold, and the picture doesn’t look particularly pretty for the bottom 99 percent of nonfinancial corporations. Their cash on hand as a percentage of the debts they owe is
at its lowest level in a decade, according to S&P. More than 50 U.S. companies have defaulted on bonds or loans so far this year, double the number in the same period in 2015. Among the companies that have missed payments, according to S&P: Peabody Energy and Midstates Petroleum. For the most part, companies aren’t pouring the money they borrow into capital expenditures to increase efficiency and capacity—investments that could boost profits down the road. Instead, much of it has gone to finance share buybacks, dividend hikes, and acquisitions. Since 2009, S&P 500 companies have spent more than $2 trillion to repurchase shares, helping sustain a rally in which stock prices almost tripled. Mergers and acquisitions worldwide jumped about 28 percent last year, to $3.5 trillion, according to data compiled by Bloomberg.
“If you put yourself in the seat of someone responsible for management of a company, they see weak demand,” Federal Reserve Governor Jerome Powell said in a May 26 appearance at the Peterson Institute for International Economics in Washington. “They can cut costs, and they can buy back their stock, and they can make their numbers that way for a period of time.” McDonald’s sold $6 billion of bonds at the end of last year to help finance higher dividends and share buybacks.
Buybacks and takeovers are starting to tail off as companies feel the effects of falling profits. S&P 500 earnings from continuing operations fell 7 percent in the first quarter of 2016 from a year earlier, data compiled by Bloomberg show. After stripping out energy companies affected by weak oil prices, earnings were still down 1.4 percent. “There is newly intensified, broadbased pressure on business to cut capital spending and inventories,” David Levy, chairman of consultant Jerome Levy Forecasting Center in Mount Kisco, N.Y., wrote in a report to clients in May. Earnings are being squeezed by lagging worker productivity and mounting labor costs as rising demand for workers forces companies to pay more. Corporations also are confronting lower economic growth expectations. Richmond Federal Reserve Bank President Jeffrey Lacker says he now pegs the potential expansion rate of the U.S. economy at 1.5 percent. That’s half the average pace in the quarter-century that preceded the December 2007 start of the last recession. Lonski of Moody’s says it’s premature to predict that the U.S. is heading
into a recession as employers are still adding workers to their payrolls, albeit at a slower rate. Yet the pressure on companies is “a risk factor that’s worth watching,” he says.
The bottom line U.S. companies may have gone overboard borrowing at cheap rates to fuel stock buybacks, dividends, and acquisitions.