The likelihood of corporate bankruptcies is being exaggerated - Part 2
The other day I blogged about how I strongly believe that the people who state that the vast majority of corporations will file for bankruptcy in the near future are way off base. The evidence that I cited is that corporations still have a tremendous amount of cash on their balance sheets. Despite the recent economic weakness, according to Compustat the percentage of cash on companies' balance sheets still sits at 22% a solid of companies' total assets (excluding banks and utilities which have cash requirements set by regulators).
Of course, nothing gets past the astute CAPS members, and top players including portefeuille and devoish, asked me natural question "What has happened to corporate debt?" Ask and ye shall receive my friends. Today I have your answer.
Even with the United States in the midst of a terrible recession, corporate liquidity is actually in pretty good shape. According to a recent research report that the firm Lord Abbett compiled using data from the Federal Reserve, as of the end of the fourth quarter of 2008 the debt-to-equity ratio of American corporations stood at a reasonable 46.2% of total capital. After all of the write-downs and charges that we have seen over the past year and all of the talk about how American corporations are leveraged up to their eyeballs, the debt-to-equity ratio of U.S. companies is lower today than the 56% that it stood at in the mid-1990s.
Furthermore, corporations are currently sitting on enough cash and short-term securities to pay off approximately 20% of this debt.
Add to this the fact that even in this depressed environment, in most cases corporate cash flow can easily cover companies' debt. As of the fourth quarter off 2008, net interest rate payments only accounted for 18.8% of cash flow of non-financial corporations. That's up from the 14% of cash flow that debt consumed in Q3 '08, but it is not at all elevated by historical standards. Interest consumerd a whopping 30% of cash flow from mid-1989 through mid-1990 and over 25% of cash flow from the second half of 2000 through the first half of 2001.
Of course some companies are going to go bankrupt. Moody's (HAHAHAHA, oh excuse me) estimates that 16.4% of all junk bonds will eventually default by the end of the year. Similarly, Standard and Poors (HAHAHAHAHAHAH, oh there I go again) estimates that by March of 2010 14.3% of all junk bonds will default. Both of these estimates would exceed the record of 12.54% for junk bond defaults that was set back in July of 1991.
Having said this, junk bonds represent a very small sub-segment of total corporate debt. So even in a worst case scenario we're talking about only less than 20% of the companies that are in the absolute worst shape in the U.S. going bankrupt. That certainly is a lot less than the kooky predictions of the majority of all companies going bankrupt that I have seen being bandied about.
Not only is corporate debt not the problem that it has been made out to be, but the credit markets are thawing rapidly. So the companies that do have debt coming due, and the vast majority of near-term junk debt does not mature until 2011, can refinance their debt much more easily today than they could several months ago. The average yield on junk bonds has fallen from 20 points over similar Treasuries to the less than 13 points over that it sits at today.
These are the real facts, not some arbitrary horrible numbers pulled out of thin air. Companies certainly will go bankrupt during this horrible recession and that is a terrible thing for the people who are invested in them and the poor souls who work for them, but this is not the end of the world like many would like to make it out to be.
I'm off to have supper with my family, but I wanted to share this with everyone as soon as I found it out. Talk to you tomorrow.