BofA: “2018 Is When Bond Investors Again Get Very Concerned About Fundamentals”
One week ago, we closed the book on the long-running debate whether gross (and net) leverage is the highest on record, when we showed a chart from Goldman according to which net debt/EBITDA for all companies (with or without energy) is the highest on record, surpassing the previous credit bubble peak by nearly 0.3x turns. Furthermore, as Goldman said that the time, “given we are 8+ years into an economic expansion, we believe it’s prudent to also view this via a “normalized EBITDA” lens (i.e., median NTM 2007Q1-2017Q1). On this basis, aggregate leverage (ex- Energy) would move up to 2.1x, roughly 20% higher than current levels and 18% above the prior cycle peak.“
Of course, none of the above matters right now; in fact if anything as Friday’s oversubscribed Tesla bond sale as well as yesterday’s massively oversubscribed sale of Amazon bonds confirmed, investors still can’t get enough of corporate debt.
But how much longer can this relentless re-leveraging continue before something snaps, or before someone finally pays attention? According to BofA’s chief credit strategist, Hans Mikkelsen, the answer is 2018.
We republish from our weekly the preliminary review of 2Q US high grade credit fundamentals. As highlighted in that piece gross leverage (ex. financials, commodities and utilities) jumped 0.11x to 2.38x, nearly matching the all-time high of 2.41x reached in 1Q 2002 during a recession.
Recall that the 2017 BofAML Corporate Risk Management Survey showed that roughly two-thirds of US companies do in fact plan to use some of the overseas cash to pay down debt. A lot of companies – but not as many – also have plans for each of the categories “Share repurchases”, “M&A”, “Capital expenditure”, “Dividends”, “Fund Pension” and “Other”. But these are also the usual uses of proceeds for new issuance, suggesting that that overseas cash will be used over time in place of supply, thus further reducing gross leverage as existing bonds mature. However, even despite this corporate balance sheets overall will remain relatively stretched and we think that 2018 is when corporate bond investors again get very concerned about fundamentals… This as less uncertainty about US fiscal policy, and continued economic growth of just around 2%, incentivize companies once again to accelerate M&A and share repurchases.
Well, if this is what “less uncertainty about US fiscal policy” looks like just over a month before a debt ceiling debate which increasingly looks like it could result in a technical default by the US, we would hate to see what more uncertainty is. What is just as ironic, is that in the very same BofA report, however by a different author, we read that in the second quarter, borrowing by high grade corporations outpaced earnings, again.
We provide a preliminary read on market fundamentals for US non-financial high grade issuers as most 2Q results are out by now. The results show increasing leverage as companies continued to accumulate debt at rates faster than they grew earnings.
We estimate that median gross leverage increased to 2.38x from 2.27x in 1Q, while net leverage rose more modestly to 1.72x from 1.69x in 1Q. On a YtD basis gross and net leverage increased by similar 0.16x and 0.18x, respectively, from 2.22x and 1.54x in 4Q-2016 (Figure 4). Coverage also weakened to 10.69 in 2Q from 10.89 in 1Q (Figure 5)…. YoY debt growth accelerated to 2.3% during the quarter after slowing down to 1.5% in 1Q. Margins and liquidity were both mixed in 2Q and capex growth rates remained little changed at low levels. While the pace of supply moderated in 2Q from the record pace in 1Q (Figure 6), the aggregate market debt rose 3.6% QoQ, outpacing the increase in LTM EBITDA by almost a percentage point, resulting in higher leverage. Most of the largest leverage increases were related to M&A funding. Companies also likely front-loaded issuance to take advantage of lower interest rates.
BofA’s attempts at spin aside, we agree that even in a case of “higher uncertainty”, whatever it may look like, companies would probably issue even more debt, as they rush to take advantage of every last greater fool out there investing with other people’s money, before the rug is pulled out from a buyside community which appears to be staffed almost entirely with 20 year old “managers” who have never, in their professional lives, seen a debt crisis.