Cash is always appreciated around Christmas. How nice, then, that a record number of companies are making special payouts, ahead of expectations of higher U.S. taxes on dividends. The latest round of payouts stems from unique circumstances – the fiscal cliff – but is also part of a larger trend. After bolstering their balance sheets following the financial crisis, U.S. non-financial companies are adding leverage again.
In a lacklustre economy companies have been under pressure to boost shareholder returns, dipping into the cash piles accumulated in recent years or, in some cases, adding debt. The flurry of special dividends follows other shareholder-friendly moves: dividends and share buybacks began rising last year.
Net leverage is also rising. Opportunistic issuers have seized upon historically low borrowing costs to issue cheap debt beyond their refinancing needs, for reasons including dividends and buybacks. Operating earnings, meanwhile, have declined. For non-financial companies in Barclays' index of dollar-denominated investment-grade bonds, the ratio of net debt to earnings before interest, tax, depreciation and amortization bottomed at 1.25 times in the second quarter of 2011. It has since risen to 1.5 times – above pre-crisis levels.
The combination of rising leverage and a renewed focus on keeping shareholders happy does not bode well for a continuation of the rally in corporate bonds, which this year alone have returned 10 per cent. The good news is that companies have added debt at low interest rates. Average yields on new investment grade corporate debt are more than three percentage points lower than they were in 2006 and 2007, allowing highly rated companies to shoulder more debt at roughly the same cost, Barclays data show. But if the economy sours, eating further into EBITDA, higher leverage will prove to be a terrible gift for investors.