It's Not The Record High Debt That Is The Biggest Risk, It's This

Tyler Durden's picture

Earlier today, Bloomberg "discovered" that "Corporate America Has Quietly Re-levered", reporting that "one of the biggest post-financial crisis imbalances sits on corporate balance sheets" citing a Goldman report.

Actually it hasn't been quiet at all: while to some this is news, our readers have been well-aware of this trend since January 2014 when we first reported that "Corporations Have Record Cash: They Also Have Record-er Debt, As Net Leverage Soars 15% Above Its 2008 Peak", and then most recently this weekend when on Sunday we reported, again very unquietly, that "Corporate Leverage Is At Record Levels."


Furthermore, as we further noted in "Why The Stock Buyback Spree Is Ending" that "the 3-fold increase in share buybacks in the past five years has been the key driver of corporate re-leveraging. In large part, buybacks have been the result of strong incentives provided to corporate managers by activists in particular and equity investors in general."

Two days later, Goldman also confirmed this observation: "So, does this mean the levered re-cap is dead? In our view, the answer is yes for the broad market, though legacy Tech should prove an exception given substantial balance sheet capacity"

Goldman added even scarier overtones overnight, when it said that "like a bad dream, imbalances have been building the last few years. Corporates have levered up and the M&A boom has driven goodwill to multi-year highs. With the United States on the verge of the first interest rate hikes in almost a decade, we question the sustainability of these trends. Companies that have “manufactured earnings” vs. generating organic growth and reinvesting in their businesses are in the spotlight with investors rewarding high-returning stocks while punishing those with weak balance sheets, outsized buybacks and/or EPS growth."

Bloomberg wasn't too far behind in admitting what we have said three years ago when in November 2012 we revealed "Where The Levered Corporate "Cash On The Sidelines" Is Truly Going", i.e., buybacks.

* * *

But while even Goldman has admitted that rising leverage and the soaring buybacks are, "like a bad dream", the major problem for corporate imbalances, the truth is that surging debt is not the full story, nor is it the scariest aspect of this story.

The real risk is that while debt is rising on both a relative and an absolute basis, EBITDA, or cash flow, of both junk companies as well as Investment Grades, has been declining for at least one year. Or rather, while junk-rated companies have seen their EBITDA decline consistently over the past 5 years, the big inflection point came in early 2014 when IG EBITDA also plateaued, and has been declining since.

It is this ongoing decline in actual cash flows, which tracks the third consecutive quarter of declining Y/Y revenues (the decline in EPS is far slower as hundreds of billions in shares have been removed from the market, keeping the EPS ratio higher than where it would be) that is the biggest risk to both the S&P500 and the market, if such a thing still existed.

Even Goldman is unable to provide a counterfactual case:

Now, the counter-argument one hears is that the cost of this debt has never been this cheap with the average interest rate paid dropping from close to 6% to 4% in 2015. Put another way, as debt has more than doubled, the amount of interest expense has only gone up by 40%. This is all good until you normalize EBITDA. Indeed, if EBITDA was at “normalized levels” (which we define as median NTM EBITDA from 1Q07-2Q15), leverage would move to 1.75X, over 30% higher than the average over the last 10 years.

But here is the real kicker: with even Goldman admitting that buybacks as a shortcut to creating "engineered" earnings will no longer work and instead may be punished by investors, companies refuse to accept this. Certainly don't tell that to McDonalds, which earlier today defied S&P to announce a major debt increase to boost shareholder returns, even if it meant its A rating would be lost as it was downgraded to BBB+. Contrary to Goldman's take, it was rewarded by shareholders.

So even as cash flows continue to decline, companies will engage in this one and only line of defense against sellers and shorters as in a world where 2% growth is the new norm (and that with the benefit of $13 trillion in central bank liquidity). And instead of investing in the future, replenishing their asset base, this asset stripping of corporations to reward shareholders will continue.

Until it can't, an threshold which will certainly be catalyzed by any Fed rate hike(s).

At that point, desperate for cash companies (loaded to the gills with debt) will again try to access the bond market and be unsuccessful. It is then when the bulk of the S&P, cash flows declining, will resort to the oldest form of capital raising in the book - selling equity. From that point onward, it will be all downhill for the market.

The only question is how many savvy shareholders will try to frontrun it and sell while they still can, not when they have to, and are competing with management to find willing buyers.

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CaptainAmerika's picture
CaptainAmerika (not verified) Nov 10, 2015 6:09 PM
Rainman's picture

okay ....they non-GAAPed some folks. Corner office #winning !!

Lets Buy The Dip's picture

haha very clever there. 

The debt is what debt is, an instrument by the POWERS THAT BE to sucker you in, and then they have you by the balls, can do with you what they want. Like the subprime, that scam went down as the biggest in the world. We all were had. 


With debt, people keep saying last 8 weeks is looking for a crash, but it still is not coming. Plus I doubt listening to the bears is going to help anyone, why? simple….

This video here, shows that we are now back in a FULL on bull market. =>

So next year, more up is coming, could be lots more up. Time will tell.

buzzsaw99's picture

so. fucking. what.

janet will buy them.

Crocodile's picture

They need only to prop up eight stocks to keep the illusion alive.

two hoots's picture


It is just more of the same inequality.  Businesses with excess cash should redistribute it to those without.   Businesses are people too.  It is only fair (if all details are excluded).  B.O.


HARM's picture

They *are* redistributing it to those without: politicians, lobbyists, tax lawyers, etc. Of course, they expect something in *return* for that "investment". Like more giant tax loopholes, credits, federal subsidies, and other sundry corporate welfare.

herkomilchen's picture

"engineered" earnings will no longer work and instead may be punished by investors

This is the key question facing all of us.  Will investors have this reaction to moar financial engineering?  And will markets respond similarly to next year's Fed's abandonment of pretense at rate hikes and launch of QE4?

A short is gambling so.  A BTFDipper says the gears of this hateful system will grind on pushing everything upward on paper straight through hyperinflation and currency collapse.

Ajax_USB_Port_Repair_Service_'s picture

Interest rates will never go to 4% or 5% or 7% or 10% or Jimmy Carter 15%. Nope, rates will never go up ever ever again!

Heaven on earth!

Youri Carma's picture

The ending of stock buybacks call has been made too early before. Of course it will end but when is always the 100-Bill question. And indeed if the companies themselves don't prop the S&P ol Yellah will.

Batman11's picture

In search of short term profit and dividends Wall Street has led US companies down a blind alley.

They have frowned on long term investment and R&D as these dent short term profits and dividends.

They prefer layoffs, asset stripping and mergers and acquisitions to boost short term profit and dividends.

Companies that once issued stock to grow now take on debt to buy back their shares that increase the share price and dividends for the other share holders.

Increasing stock was always much better than debt for investment. With stock you pay dividends depending on how well the company is doing and it doesn’t drain the company in the bad times. Debt repayments stay the same good times and bad.

Wall Street has strip mined the real companies of the US economy and left them in no position to grow without long term investment and R&D.

The UK was the last super power and China will be the next.

Adios America.

To see how bad it is read Michael Hudson's book "Killing the Host".

DavidC's picture



In other words a useless measure meaning nothing.


MEFOBILLS's picture


Ebitda:  An acronym for earnings before interest, taxes, depreciation and amortization; more commonly known as cash flow in recent past.

Finance capitalism sees any source of cash flow as economic prey.  For example: industry profits, taxes, and any sort of disposable income over basic needs, can be targeted by finance.  Finance does not differentiate on channels of flow any source of revenue is fair game.

The accrual of interest collected from loans is limited only by ability of borrowers to pay said interest on their debts.

These interest charges will mount and grow with usury, given the nature of compounding interest.  Eventually finance charges on money will grow to the limit and ability of borrowers to pay.

Interest charges on rising debt levels absorb business and personal income, leaving less available to spend on goods and services. Economies shrink and profits fall, deterring new investment in plant and equipment.

These interest charges vector into a loop of finance, thus voiding Says law of circular flow.

Labor already cannot buy their output due to waste and losses passed on in higher prices, but adding in the price of money, means that labor is driven down to the lowest wage level possible.  Finance escapes these dynamics as they exist in a separate loop of the economy.  This separate loop is mostly a free lunch taken from the productive in the form of high prices.

EBITDA, T  taxes return into the circular flow as they are respent.  Interest is wasted charges as it vectors into finance.  Depreciation and amortization acknowledges that machines wear out, and a portion of capital needs to be returned to be re-invested e.g. tax breaks.    D and A is recovery of capital outlays.

But, if interest on credit is given a tax break like D and A, then it has occupied a special place in industry as if it was a necessary cost of business.

Deducting interest charges then encourages new credit as money to be borrowed.  Bankers make keyboard entries on their ledgers, and viola credit is created along with interest carrying charges. 

Taking out new loans, to then buy up your company stock, allows stock price to be pushed.  It then allows interest carry charges to be put on the books.  Pushing up stock prices grows stock options.  Pushing stock prices with new credit as money is a rent scheme. Interest charges then find their way to make higher prices. 

Captains of industry siphon away what should be D and A reinvestment, and instead grow I charges to push stock prices.


EBITDA tells accountants how much cash flow can be vectored away to become dead weight of finance.

(I differentiate between money and credit.  Money that was saved and is stored wealth, should have interest charges.)

hedgiex's picture

EBITDA What's that ? You mean that this relic still sells ?

toros's picture

Here's one for you. The biggest monthly candle stick since Mobi Dick!

What'st that like a $200B sperm whale?

Antipodes52's picture

Higher debt doesn't matter if interest rates stay low forever...