First quarter U.S. GDP growth disappointed analysts, though corporations, excluding the energy sector, bucked the naysayers. In late April, we learned the U.S. economy expanded 0.2% (real quarter-over-quarter annualized) and corporations’ top lines grew 2.2% (excluding the energy sector, which is being dragged down by lower oil prices). As of this writing, roughly 85% of corporations have provided first quarter 2015 earnings, and not since 2012 has earnings before interest, taxes, depreciation and amortization (EBITDA) expanded by greater than the 5% reported in Q1. This is an indicator of U.S. corporate resilience, especially considering the increased value of the dollar. However, corporations levered up in the first quarter of 2015. Driven by the desire to continue returning capital to shareholders (via share repurchases and dividend increases), and in order to take advantage of low borrowing costs, corporations exceeded issuance in the first quarter of 2014, reaching $500 billion. It took until mid-June of 2014 for corporations to issue that much debt, a one-month difference. Two thousand fourteen, however, was already a record year for issuance. In total, corporations issued $1 trillion of debt, and it appears that in 2015 a new record will be set. JP Morgan’s credit research group notes that profit margins and interest coverage, both of which are key inputs in assessing credit quality, continued to be strong for companies having already reported. All things considered, we are not bothered too much by additional leverage (indeed, it’s much harder to grow earnings than it is to issue debt), and are encouraged by solidifying fundamentals outside of the oil sector. We expect borrowing rates for corporations (“corporate spreads”) to decline slightly once the Federal Reserve increases its policy rate and the pace of corporate bond issuance slows down a bit.
Sources: JP Morgan, Bloomberg, SNWAM Research