Notes from the desk is corporate leverage offering a warning sign – sage advisory industrial electricity prices by state


As several market observers have written, corporate leverage continues to increase. Specifically, leverage, or the ratio of a company’s debt to cash flow, has increased noticeably among non-financial corporate bond issuers since 2010. Investment Grade issuers in this cohort have increased their Debt/EBITDA ratios from 2x to nearly 3x in this time frame, according to data from the St. electricity bill saudi electricity company Louis Federal Reserve (see below).

Regardless of the ultimate use of funds, the simplest reason why corporations have increased borrowing is also the most likely: because they can. Companies are more comfortable than ever with higher leverage and lower credit ratings because the market has not yet punished them for it. Over decade ago, only 25% of investment grade issuers carried a credit rating below “A.” Now, nearly 50% of the Bloomberg Barclay’s Corporate index is rated “BBB.” In addition, the extra spread demanded by investors for investing in BBB-rated credit vs. A-rated credit has hovered in the 40-to-70 basis point range for most of the time period following the 2008-2009 financial crisis. Many CFOs figure that paying an additional 0.50% of coupon yield for lower ratings and another turn or two of leverage is worth the gamble — if it allows them keep equity prices high, since equity returns are often correlated with management compensation.

This conflict of interest between management teams and bondholders also drives another self-fulfilling prophecy: borrowing money to help improve equity returns at the expense of credit quality leads to higher equity returns, which leads to more complacency amongst bondholders. gas city indiana post office Bondholders often look at “equity cushion” as a mitigating factor against increased leverage. They reason that if equity investors are willing to pour money into the capital structure at a level junior in priority to unsecured bondholders, then bondholders should feel relatively more comfortable with the risk of lending to the entity. The strong equity market returns of the past nine years has made the increase in leverage seem less significant to the capital structures of most companies than it actually has been.

A bank’s tier 1 risk-based capital ratio is a measure of liquidity and financial health. Tier 1 capital is a bank’s equity capital and core reserves. o gosh corpus christi The ratio is calculated by dividing tier 1 capital by total risk-weighted assets. While major banks are required by Basel III regulations to hold a ratio of 6% or greater, on average most large banks have ratios in the 13% range, more than double what is required by law.

At Sage, we believe that now is the time to “sharpen the pencil” and go to work analyzing credits more closely, as dispersion in returns is likely to increase dramatically. As the large global Quantitative Easing program being orchestrated by Central Banks begins to wind down, companies that have weak financial fundamentals will see increased scrutiny from analysts and in some cases, will have trouble accessing capital markets to refinance debt. Given this possible outcome, we’ve developed a credit playbook for selecting the winners from the losers:

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. grade 6 electricity worksheets Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

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