Debt and Delinquencies Way Up After 7.75 Years of “Economic Recovery?”
by the Curmudgeon
We’ve many times called attention to exploding levels of corporate debt, most recently in last weekend's Curmudgeon post. In less than one week, the US corporate debt has gotten worse, delinquencies have risen as have credit card defaults for sub-prime consumers. It’s beyond macabre and we submit the Fed is the instigator, while financial regulators are still asleep!
Corporate Debt Build Up Worsens:
USA Today reported
in its October 26th print edition that tech companies in the Standard &
Poor's 500 index now have $451.4 billion in long-term debt, up 42% from just a
year ago. For example:
· Apple came into the third quarter owing $68.9 billion, more than any other tech company and up 45% from the prior year.
· Video-game maker Electronic Arts, which had no long-term debt a year ago, now owes just shy of $1 billion.
· Just this week video streamer Netflix sold $1 billion in debt, a sizable sum that adds to the company's existing $2.4 billion pile of long-term debt.
"They (Netflix) are spending a lot of money, and they're using debt instead of equity," says Neil Begley, analyst at debt-rating service Moody's Investors. "They used cash flow before as a governor of growth. Now they're borrowing to launch."
Companies Hoarding Cash Overseas While Borrowing in US:
Yet tech companies have boat loads of cash they're hoarding- right? Not so fast. Tech companies ended the second quarter with $610.1 billion in cash and short-term investments, which is more than that of the next three richest sectors combined. Yet many tech companies are using debt to buy companies that are growing faster, says John Moore, analyst at S&P Global. Tech companies account for 20% of buyouts this year.
Also, much of that corporate cash is parked overseas, which is subject to corporate income taxes if repatriated back to the US. By borrowing in the US, tech companies have cash to pay dividends and buy back stock without triggering a tax event by bringing the cash home. Technology companies, including Microsoft, Apple and IBM account for 53% of cash held overseas, says research by David Zion at Credit Suisse.
IBM, the uncontested poster child of financial engineering (according to Business Week) on Tuesday announced a $3 billion stock buyback program. Yet its long-term debt rose by $6.3 billion in the second quarter from the same time last year. Many tech companies "don't want to repatriate cash and pay taxes," Begley says.
Fed’s ZIRP and Ultra Low Rates Spur Corporate Borrowing:
We've pounded the table for years that Fed ZIRP and rounds of QE have motivated companies to borrow at ultra-cheap rates (often, below the inflation rate) to increase dividends, buy back stock, pay executive bonuses and use for takeovers/mergers & acquisitions. Rock-bottom borrowing costs makes leverage affordable and difficult for any US based company to ignore.
All 10 non-financial S&P 500 sectors boosted long-term debt in the second quarter from the same period last year. Debt among all companies has risen every year since 2009 to hit $6.6 trillion last year, S&P Global says. Early indicators point to a surge in more debt, as the number of filings for new corporate bond identifiers hit a 14-month high in September, CUSIP Global Services says. "The Fed is basically subsidizing debt," Mark Marcon of Robert W. Baird told USA Today. And as we’ve stated so many times, the REAL ECONOMY HAS NOT BENEFITED from ultra-low rates!
AT&T –Time Warner Acquisition to be Financed by Huge Debt Increase:
The WSJ reported on Monday Oct 24th in its print edition- Time Warner Deal Adds to AT&T’s Heavy Debt Load (on line subscription required):
Buying Time Warner Inc. will make AT&T Inc. among the most heavily indebted companies on earth.
In a deal announced Saturday, AT&T agreed to pay $85.4 billion to buy the owner of CNN, HBO and TNT networks. Including debt, the value grows to $108.7 billion. And to finance the half-cash, half-stock deal, AT&T is taking on $40 billion of bridge loans.
AT&T, the largest non-financial corporate issuer of dollar-denominated debt, already has about $119 billion in net debt—roughly double what it was five years ago. “This would put them, I think, within striking distance of the financials with respect to unsecured bond issuance,” says Mark Stodden, a credit analyst at Moody’s.
Mr. Stodden estimates the carrier’s total debt load will grow to as much as $170 billion if the deal is approved. AT&T hasn’t said precisely how much debt it plans to issue to fund the transaction, but estimates that by the end of the first year after the deal’s close, net debt will be around 2.5 times its adjusted earnings, up from 2.24 times at the end of the third quarter.
Corporate Default Rate Up Sharply:
The US corporate default rate is expected to jump 30% and hit 5.6% by June 2017, according to a jarring warning issued by credit-rating firm S&P Global Fixed Income Research.
Financial stress applied mainly by falling oil prices is "a driver of defaults" and why 99 US companies with the lowest credit ratings could default during the 12 months ended June 2017. That would be dramatically higher than the 79 US companies that defaulted in the 12 months ended June 2016, which resulted in a 4.3% default rate, S&P Global says.
Much of the pain is in the energy sector. Stocks in the energy and natural resources industries have accounted for 57% of defaults the past 12 months, S&P says.
Credit Card Delinquencies Creep Up to Highest Levels Since 2012:
2.2% of credit card holders are now in default. That's the most since the market collapsed in the sub-prime loan crisis. What have our beloved credit card companies (mostly banks) been doing about it? They issued over 20M new credit cards to sub-prime borrowers in 2015 and that's up 56% from 2013. And the borrowers paying those crazy penalty rates are, of course, the ones who can least afford them: Missed payments in states with large oil or energy sectors continue to worsen.
The share of card balances that were at least 90 days past due increased 12% in Oklahoma, 10% in Texas and 20% in Wyoming in the third quarter from a year prior, according to TransUnion as reported by Zero Hedge.
The chart below shows the slow, but steady delinquency rate on credit card loans.
Chart Courtesy of the St. Louis Federal Reserve Bank
An October 25th WSJ article titled Sub-Prime Credit Card Surge Pushing Up Missed Payments, noted that the credit quality of borrowers has declined materially over the past couple of years. In fact, the volume of sub-prime credit card issuance was up 20% year-over-year in 2015 and 56% compared to 2013.
Lenders ramped up sub-prime card lending in 2014 and have been doling out more of these cards recently. They issued just over 20 million credit cards to subprime borrowers in 2015, up some 20% from 2014 and up 56% from 2013, according to Equifax.
Meanwhile, declining household income related to the oil bust has also led to higher delinquencies.
We are tapped out on making the same points over and over again. Each time with new documentation, charts and figures to corroborate that Fed monetary policy has been counter-productive and has created huge problems down the road for the real economy. The stock and bond the markets have ignored this for years, which is why there is a CURMUDGEON as a source of TRUTH behind the smoke screens, hocus pocus, accounting shenanigans, and fudged financial data.
When a recession really hits hard, how will all the newly created debt be serviced? If corporate debt and defaults are rising steeply now, what will happen to default rates when there is negative economic growth and companies are losing money? Ask yourself, how is corporate America REALLY doing after 7.75 years of “economic recovery?”
Good luck and till next time...
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Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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