Are Corporate Bondholders Chopped Liver?
U.S. nonfinancial corporations have enjoyed a surge in internal funds (book profits plus depreciation minus accrued taxes and dividends paid) in recent quarters. As shown in Chart 1, nonfinancial corporate internal funds in the third quarter soared to 125% of capital expenditures - a near record high. That is, corporations generated a lot of cash in the third quarter relative to their spending on capital goods and inventories.
Chart 1
Now, you would think that with all this "excess" cash being generated by Corporate America in recent quarters, it would not be tapping the credit markets for many funds. But, although nonfinancial corporate borrowing edged a touch lower in the third quarter, it has been trending up toward the highs of the late 1990s (see Chart 2). Moreover, corporate borrowing relative to capital outlays also has been trending higher again.
Chart 2
Why isn't Corporate America paying down debt if it is flush with cash and not on capital spending sprees? Perhaps because if it cut back on its borrowing, it might not be able to retire as much equity. Chart 3 shows that nonfinancial corporations retired their equities at a record annual pace of $446.2 billion in the third quarter. So, just as it was in the late 1990s, it is once again all about the stockholders, with the bondholders being relegated to chopped liver. When economic growth downshifts in 2006 and so does corporate profit growth, corporate bondholders may start to feel a little exposed. With less cash being generated by corporations with which to buy back shares, even stockholders may begin to feel a bit exposed.
Chart 3
It has come to my attention that some readers think that it is a misnomer to call my quasi-weekly essay "Positive Economic Commentary" given its sometimes negative spin on economic and financial market developments. Of course, the term "positive" is meant to connote the opposite of normative, as implied in the subtitle, "The economics of what is, rather than what you would like it to be." But here in the economic research department of The Northern Trust Company, we aim to please. Therefore, I am announcing a contest to rename this commentary. The person submitting the best title in the opinion of the judges (me) gets a one-year free email subscription to the commentary. The person submitting the worst title gets a lifetime subscription.
Happy Festivus, the holiday for the rest of us.
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Author: Paul Kasriel
Paul L. Kasriel
Director of Economic Research
The Northern Trust Company
Economic Research Department
Positive Economic Commentary
"The economics of what is, rather than what you might like it to be."
50 South LaSalle Street, Chicago, Illinois 60675
Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul's 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst. Through written commentaries containing his straightforward and often nonconsensus analysis of economic and financial market issues, Paul has developed a loyal following in the financial community. The Northern's economic website was listed as one of the top ten most interesting by The Wall Street Journal. Paul is the co-author of a book entitled Seven Indicators That Move Markets.
Paul began his career as a research economist at the Federal Reserve Bank of Chicago. He has taught courses in finance at the DePaul University Kellstadt Graduate School of Business and at the Northwestern University Kellogg Graduate School of Management. Paul serves on the Economic Advisory Committee of the American Bankers Association.
The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The information herein is based on sources which The Northern Trust Company believes to be reliable, but we cannot warrant its accuracy or completeness. Such information is subject to change and is not intended to influence your investment decisions.
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