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The likelihood of corporate bankruptcies is being exaggerated - Part 2

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May 17, 2009 – Comments (15) | RELATED TICKERS: JNK

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.

Deej

15 Comments – Post Your Own

#1) On May 17, 2009 at 8:00 PM, goldminingXpert (29.50) wrote:

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.

Who is predicting this? I'd like to know their trades and fade them.

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#2) On May 17, 2009 at 8:11 PM, alstry (35.96) wrote:

Do you ever notice how you always cite sell side analysts as the basis for your presentations?  These are the same guys who were bragging how good employment was a couple years ago and how it was very unlikely we would see a recession last year.

Aren't you a bit embarassed using their data as support for your presentation?  If I hung around you, I sure as heck would be and might even lose a bunch of respect for your citing a bunch of people who have been consistently wrong.

But that make you Deej I guess.

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#3) On May 17, 2009 at 8:14 PM, alstry (35.96) wrote:

Furthermore, corporations are currently sitting on enough cash and short-term securities to pay off approximately 20% of this debt.  

Holy Cow Batman!!!!  A whopping 20% of debt....that would make any wife secure if her husband had enough cash to pay off 20% of their debt and evaporating income.

How much thinking is going on in your analysis....or do you just spout things off????????????????????????????

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#4) On May 17, 2009 at 8:25 PM, RonChapmanJr (37.04) wrote:

Why not just put Alstry's name in your blogs, Deej?  It is obvious you are talking about him, why not just say it?  I could care less about the feud you two seem to have, but if you are going to talk about him, you might as well be straightforward about it.

ron

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#5) On May 17, 2009 at 9:17 PM, TMFDeej (99.26) wrote:

Hi Ron. This blog was actually a follow-up post with ansers to questions that the intelligent CAPS community members portefeuille and devoish asked in the comments section of a previous post.

Many people are predicting the end of the world, not just one single person.  One has to be careful when they do though because it only happens once. 

I find it in poor taste to get into flame wars and to single out individual bloggers.  That sort of thing is for places like Yahoo!, not respectable investment communities like this one.  Besides, when that sort of thing happens, it usually just devolves into one of the participants tastelessly talking about the other's family, wife, father, underwear, balls, and other things things like that...

My point is, Ron, that the economy is bad and that it is getting worse but the pace of the implosion is slowing.  A bottom will be reached at some point, probably in 2010 and we will experience an extended period of sub-par growth.

However, I find it highly unlikely that unemployment will soar to 50% and that 90% of all companies will go bankrupt.

The things that I cited in my article are real facts, not made up numbers.  The only forecasts that it contains are about junk bond defaults and I definitely take those numbers with a huge grain of salt.  These things like cash on the books, debt-to-equity ratios, cash flow, etc... are the real facts.

Deej

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#6) On May 17, 2009 at 10:41 PM, alstry (35.96) wrote:

Deej in plain English:  

My point is, Ron, that the economy is bad and that it is getting worse but the pace of the implosion is slowing.

Ron what I am really trying to say is the patient is dying, it is just that the rate he is dying at is bit slower.....otherwise he would be getting better and I would never want to lie.

The things that I cited in my article are real facts, not made up numbers.....corporations are currently sitting on enough cash and short-term securities to pay off approximately 20% of this debt.

Can you believe it Ron, revenues are contracting at rates never before seen in American history across many different industries and coporations only have 20% of debt in the bank.  Even though I have never owned a business.....I am from the debt generation and 20% seems like a lot to me....however, the tide has never gone out in my lifetime yet...but when it does...we will see who is swimming naked.

Not only is corporate debt not the problem that it has been made out to be, but the credit markets are thawing rapidly.

Did you notice Ron that on Friday, credit card defaults crossed into double digits for the first time in history....it would normally not be a big deal but the consumer is over 70% of the economy.

You see Ron, my name is Deej and I like to use the real facts and I like to be civil...I may not be quite sure of what I am talking about....but I am civil.

Even though Alstry is more right than I am...he is a jerk.  Deej is all about being civil....Alstrynomics is about being right.  And just so you know...Alstry was suspened on Friday morning because either me or Donner complained about him for not being civil even though I like to bait him with my blogs.

You see...I am one of those people who like to bug people and than run away and tattle tale....but remember, I am a civil blogger who sometimes inadvertantly uses misleading data...like 2006 solvency figures... to make my point.

Yes...Alstry is a jerk...but he likes to make sure investors get both sides of the data.....me, I like to be nice and tell people that having only 20% of debt in the bank is a really great position to be in....

No wonder Alstry had so much fun with negligence cases.

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#7) On May 17, 2009 at 10:43 PM, RainierMan (74.21) wrote:

I always enjoy your blogs; you do crunch the numbers, which I like. 

Not that I think the most dire predictions are going to happen, but don't you think the averages are probably telling us that a lot of companies might be in trouble. If we're looking at a bell curve of debt-to-equity, many companies won't be in a great position. Debt-to-equity approaching 50 percent or more does seem unhealthy given the structural shift in the economy we seem to be facing. And how easily will companies be able to roll their debt if interest rates go up and revenue goes down compared to previous years?

I wonder how many companies go bankrupt in a typical recession. Since most companies are small businesses, maybe it's quite high. Maybe 50 percent isn't all that extreme? Every year we also have new business formation, which is typically high, because there are just a lot of new companies forming every year (most of which die within a few years). This would be the other side of the equation.

Maybe the dire predictions aren't really all the "out there" in light of typical measures  Just some thoughts. 

 

 

 

 

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#8) On May 17, 2009 at 10:48 PM, alstry (35.96) wrote:

Mike,

You are dead on....2/3 of all businesses fail within a few years.....but remember...Alstry is an attorney....he rarely posits an idea before knowing the answer first;)

My estimate of 70-90% is not only likely...it is practically a given.....

But my guess is Deej is a fairly young and inexperienced business person.....I only play the game because he tries to bait me..........hopefully he is getting an education without suffering any of the real pain I had to go through.

We each give in our own way and own style.

 

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#9) On May 18, 2009 at 2:12 AM, portefeuille (99.66) wrote:

I think ftalphaville offers some interesting articles on corporate debt. Have a look at: 1(see the chart of the Markit iTraxx Europe 5y index!),2,3,4,5(chart for telecoms). Current value for the Markit iTraxx Europe 5y index (ca. 134bps) and the Markit Crossover 5y index (ca. 800 bps) can be found here (the top two in the middle).

from here

The benchmark Markit iTraxx Europe index comprises 125 equally-weighted European names. A HiVol index consisting of the 30 widest spread non-financial names, and three sector indices are also published.
The Markit iTraxx Crossover index comprises the 45 most liquid sub-investment grade entities.
The Markit iTraxx indices trade 3, 5, 7 and 10-year maturities and a new series is determined by dealer liquidity poll every 6 months. 

(also see this from wikipedia)

A recent Reuters article can be found here.

An article from February 4 that illustrates the "thawing of credit markets" is here. The bottom two charts of that article show indices for North American corporate bonds. You should at least have a look at the charts!

The "CDX (North America, investment-grade) Index" (CDX.NA.IG) was at ca. 250 bps (spread) and the "CDX (North America, high-yield BB) Index" (CDX.NA.HY.BB) was at ca. 600 bps. They are now at 157 bps and 514 bps respectively (see rows 6 and 3 here).

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#10) On May 18, 2009 at 2:32 AM, portefeuille (99.66) wrote:

The Markit indices are credit default swap indices as described in the abovementioned wikipedia article. For details see this pdf document linked to that article ...

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#11) On May 18, 2009 at 2:56 AM, portefeuille (99.66) wrote:

... including portefeuille and devoish, asked me natural question "What has happened to corporate debt?"

Actually my question was not about the liabilities but about the assets (see comment #3 here):

...

Despite the recent economic weakness, the percentage of cash on companies' balance sheets still sits at 22% a solid of companies' total assets ...

Could that be (in part) be due to quickly declining non-cash assets?       ( <-- that was my question)

...

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#12) On May 18, 2009 at 2:59 AM, portefeuille (99.66) wrote:

and again (see comment #4 here):

Could that be (in part) be due to quickly declining non-cash assets?

cross out one of the "be"s ...

 

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#13) On May 18, 2009 at 3:00 AM, portefeuille (99.66) wrote:

(sorry for being "slightly" confusing, it is 9:00 a.m. here ...)

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#14) On May 18, 2009 at 9:45 AM, portefeuille (99.66) wrote:

An article from February 4 that illustrates the "thawing of credit markets" is here.

update:

Interbank lending rates drop further
Three-month interbank lending rate drops to new low 

 

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#15) On May 18, 2009 at 3:28 PM, devoish (96.56) wrote:

Deej,

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.

Prime rate was 11% in 1990, and 9% in the first half of 2001, and 4% last quarter.

So corporate debt has approximately doubled relative to cashflow since 2000 in order for interest payments to be 3/4ths at a rate equal to 1/3rd. If debt was the same payments would also have dropped to 1/3rd. These companies are at the mercy of their bankers interest rate and debt covenants, and cash flow as a percentage of outstanding debt is one that is often used (feel free to correct me, anybody).

With interest moving from 14% of cashflow, to 18% in one quarter, especially with the second one being Christmas, suggests to me that this should be looked at from the lense of which direction we are traveling on the road, less than where we are. Certainly we need at least 2 years of YOY comparisons.

The 1989 numbers have the boost of prime having moved from 20% down to 11% at the same time Reagan cut taxes. Cashflow got an artificial boost as Americans started funding their retirements (SSI and Medicare) with debty instead of cash. Meanwhile corporate debt was being refinanced lower. Todays corporate debt cannot be refinanced lower. As soon as the banks raise rates to earn profits, whether prime goes up or not, corporations with debt are dead. And the banks are raising interest rates, even if the Fed is not. Good companies with 3% loans are refinancing into 6% three months ago, CECE went from 6% to 12%, so their CEO lent back to the company himself at 7%.

According to a recent study that was published by The Journal of Finance, between 1980 and 2006 the amount of cash held by the average U.S. company ballooned from only 10.5% of assets to 23.2%.

In 1980, prime was 20%. Would you keep your money in cash or a five year Federally guaranteed CD?

I appreciate your writing every day, I know I wasn't able to, and I do learn a lot from you.

Thanks.

 

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