Ultra-low borrowing costs are once again tempting US companies down a familiar and dangerous path, luring them into propping up their share prices by issuing new debt. In a pattern all-too-familiar from the pre-crisis years, companies are piling up leverage to support their stocks just as they did before the financial crisis took hold.
And while such moves may not be setting off alarm bells just yet, analysts say, companies sitting on huge cash piles are increasingly feeling the pull in that direction. "The situation is not as alarming as during the pre-crisis years, and companies seem to be in a better position in terms of leverage versus 2008-2009, but we are moving in a similar direction," said Jayan Dhru, senior managing director at S&P.
"With continued economic uncertainty, and companies stockpiling cash because of reduced M&A activity, there are lesser places to deploy funds," Dhru told IFR. "Private equity firms like to take cash out by levering up the business, while others are buying back stock thinking tax cuts could go away, and dividends would end up being taxed at a higher rate."
US companies were very shareholder friendly in the pre-crisis years, when low interest rates and attractive stock valuations lured management teams into ignoring potential ratings downgrades in favour of increased borrowings to fund share repurchases. According to Standard & Poor's, about US $55bn was raised through borrowings to fund either dividend payments or share repurchases in 2007, and about US $56bn in 2006. Those numbers took a sharp fall in 2008 and 2009 when roughly about US $4bn and US $8bn respectively were raised to fund such activity.
But such exercises are making a comeback. In 2010, about US $54bn was used to fund dividend payments and stock repurchases, while in 2011 the number was US $57bn. This year, about US $48bn of debt borrowings had already been diverted to support equity prices just through the end of July.
"There is a temptation among companies to continue taking advantage of current debt conditions to make share repurchases, but we are not seeing the same level of levering up as we saw last year," said Philip Zahn, an analyst at Fitch Ratings. To be sure, companies are under pressure to find a home for their cash holdings. And since the Federal Reserve decided to embark on its low-rate policy in 2008, companies have been able to borrow at cheaper rates and prefund their outstanding debt.
"It is a slow-burning fuse," said Edward Marrinan, head of macro credit strategy and co-head of Americas strategy at RBS Securities. "As long as borrowing costs are lower than the dividend yields, some companies will look to take advantage of this to buy back their shares or increase dividend payments."
Meanwhile companies have more cash on hand than usual - in part because of the slow M&A climate - and some have even resorted to buying high-grade bonds or securitized products. In July, for instance, Google was seen purchasing notes in Hyundai Capital America's and Honda's auto securitisation deals. A number of companies have also boosted sagging equity prices by using the cash pile that originated from bond sales to buy their own shares.
According to a report from Fitch, share repurchase-related downgrades have also been gathering steam again, up from just three in 2010 to 12 in 2011. There have been four so far this year, the rating agency said, and some see more on the horizon. "In terms of rating actions, it may not be an imminent threat," said Marrinan. "But there will likely be at least a handful of companies which will push the envelope on their credit metrics to reward shareholders."