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U.S. Corporate Cash Reaches $1.9 Trillion But Rising Debt and Tax Reform Pose Risk

S&P Global Ratings

S&P Global Ratings' Global Outlook 2019

How Management & Governance Risks and Opportunities Factor Into Global Corporate Ratings

Countdown to Brexit: No Deal Moving Into Sight

China Inc. Will Struggle to Stay on the Deleveraging Path

U.S. Corporate Cash Reaches $1.9 Trillion But Rising Debt and Tax Reform Pose Risk

Wealth inequality in the U.S. isn't just for individuals; the divide between the haves and the have-nots continues to widen for American companies too. In fact, of the roughly 2,000 U.S. nonfinancial corporate borrowers S&P Global Ratings rates, just 25--or the top 1%--hold more than half of the record $1.9 trillion in cash and short- and long-term liquid investments as of year-end 2016 (see Methodology section). This now $1 trillion hoard is nearly twice the $510 billion they held just five years ago. Moreover, while all corporate cash grew a significant 10% last year, from $1.7 trillion at the end of 2015, the imbalance between cash and debt outstanding that we highlighted last year persists, with total debt rising approximately $350 billion, to $5.8 trillion.

To be sure, the top 1% have more than enough cash to repay their total debt of about $750 billion. But for the other 99%, credit risk remains. These issuers hold just $875 billion in cash against a whopping $5.1 trillion in debt, putting their cash-to-debt ratio at just 17%--the lowest since the 16% seen in 2008. Improving profitability hasn't offset the debt either; S&P Global Ratings' adjusted leverage is near a decade high of 2.5x for investment-grade borrowers (excluding the top 1%) and 5.0x for speculative-grade companies.


  • Cash and investments held by S&P Global Ratings' universe of rated U.S. nonfinancial corporate issuers rose by 10% to $1.9 trillion in 2016 as the rich get richer: The top 1% control more than half of this cash pile.
  • But rising debt, now at a collective $5.1 trillion for the 99%, is a concern: Adjusted leverage for both investment-grade and speculative-grade issuers is near decade highs and, conversely, the cash-to-debt ratio near decade lows.
  • At the same time, tax reform that facilitates the repatriation of roughly $1.1 trillion in cash held offshore would likely spur a wave of share repurchases, leading to lower cash balances and potentially weaker credit metrics.

Meanwhile, if the Trump Administration succeeds in passing tax reform that facilitates the repatriation of foreign earnings, we envision that a material amount of the estimated $1.1 trillion held overseas will return--and could be distributed to shareholders through dividends or share repurchases. The resulting depletion of cash, if not offset by some debt repayments, could raise borrowers' adjusted leverage and, in turn, weigh on their credit metrics and our view of their financial policies--especially in the cash-rich technology and health care sectors. Indeed, 2017 may spell the end of the great cash hoarding by U.S. borrowers.

Cash And Investments Reach Another High

The $1.92 trillion in cash held by the U.S. nonfinancial corporate borrowers we rate represents an increase of 10%, or $170 billion, from a year earlier--growth that outstrips the modest increase in our rated universe (see chart 1). The overall cash total has nearly doubled in the past seven years, while the number of borrowers we rate has increased 60%.


The cash hoarding, which began in response to jurisdictional tax disparities and global economic uncertainty following the Great Recession, accelerated over the past decade as large U.S. corporations maneuvered to accumulate profits offshore in lieu of repatriating the funds and taking a tax hit. The top 1% now hold over $1 trillion in cash, double the $510 billion reported just five years ago. The technology sector leads all industries with 44%, or over $800 billion, of the total cash, followed by health care (mostly pharmaceutical companies) at 13%, or over $200 billion (see chart 2). These two industries have particularly high proportions of their cash overseas because they accumulate much of their profits in non-U.S. countries, where most of their intellectual properties are registered.


Beware of Debt

While record cash balances make for good headlines, the more important story, in our view, is that total debt outstanding has risen roughly $2.2 trillion, to a record $5.8 trillion in the past five years (see chart 3). As it stands, cash as a percentage of debt is at 33% for U.S. corporates overall.


Removing the top 25 cash holders from the equation paints an even more sobering picture. Total debt among the bottom 99% jumped nearly $200 billion to $5.1 trillion last year, while cash rose just $60 billion to $875 billion. Some of this is attributable to the mostly speculative-grade new issuers we rated. But borrowing up and down the credit ladder continues to fuel most of the increase. In particular, many corporate sectors face modest organic revenue-growth prospects. As a result, some companies have expanded through acquisitions, often funding the acquisitions with debt. Others, mostly sponsor-owned companies, have opportunistically tapped the capital markets with favorably priced debt, at the cost of higher leverage.

We note that speculative-grade borrowers' cash-to-debt ratio is at a decade low of 13%--a significant drop from the 21% reached in 2010, and even below the 15% in 2008 during the Great Recession (see chart 4). In other words, after adding $200 billion of debt last year, these borrowers now have almost $8 of debt for every $1 of cash. (We also note that they borrowed significant amounts under extremely favorable terms in a relatively benign credit market without effectively improving their liquidity profiles.)

We see a similar trend among highly rated borrowers. The more than 500 investment-grade companies that aren't among the top 25 have cash-to-debt ratios more similar to those of speculative-grade issuers than to those in the top 1%. Their collective cash-to-debt ratio now stands near a decade low of 21%, indicating a balance sheet of $5 of debt for every $1 of cash. These issuers are generally conservative, yet the lure of cheap money continues to drive acquisitions and shareholder rewards.


Improving Profitability Does Not Offset Rising Debt

Profitability has been rising steadily, though unspectacularly, since the Great Recession. S&P Global Ratings adjusts leverage by netting what we consider to be surplus cash--generally taking a haircut of as much as 35% on overseas cash, among other adjustments--to arrive at an adjusted leverage (in contrast to gross or net leverage). Adjusted leverage has consistently trended higher in the past five years for all ratings categories (see charts 5 and 6). Investment-grade borrowers' leverage has risen by more than half a turn to 2x since 2013. Removing the top 1%, many of whose leverage is zero due to their net cash positions, yields a higher leverage of 2.5x for investment grade. Speculative-grade borrowers share a similar trend, with leverage rising by nearly a turn to almost 5x.



Top 1% Are Hoarding Cash … For Now

In 2016, the top 1% improved their collective cash position by $130 billion, to $1 trillion (see table 1). Their cash-to-debt ratio remains near the 140% area, or more than 8x better than that of the other 99% of borrowers. In 2016, these companies' total debt outstanding rose by almost $200 billion, exceeding their cash growth, as companies continued to borrow as a form of "synthetic" cash repatriation.

Despite the increase in debt, we generally view their financial policies as conservative, as indicated by their strong net cash position. The cash flow of the top 1% remains healthy and could support significant shareholder returns. But their unwillingness to repatriate overseas cash, along with an accommodative credit market, has continued to fuel the rising debt load. Technology companies, which were debt averse even a decade ago (to guard against potential industry downturns and to maintain liquidity for acquisitions and investments) have become prominent borrowers in recent years. For example, Apple has borrowed nearly $100 billion in the past four years to fund share repurchases.

Table 1
Top 25 Issuers with the Largest Cash Holdings as of 2016

Rank Company Rating as of May 22, 2017 Cash and marketable investments Total Debt Cash year over year Debt year over year
1 Apple Inc. AA+ 246.1 87.5 30.4 24.6
2 Microsoft Corp. AAA 130.1 87.8 17.0 43.4
3 Alphabet Inc. AA+ 86.3 3.9 13.3 (1.3)
4 Cisco Systems Inc. AA- 71.8 34.9 11.8 10.3
5 Oracle Corp. AA- 59.4 53.0 8.6 12.9
6 Johnson & Johnson AAA 41.9 27.1 3.5 7.3
7 Amgen Inc. A 38.1 34.6 6.7 3.0
8 Gilead Sciences Inc. A 32.8 26.3 6.6 4.2
9 Qualcomm Inc. A 29.8 11.7 (0.8) 0.7
10 Ford Motor Co. BBB 27.5 15.9 3.9 3.1
11 Inc. AA- 26.0 20.4 6.2 2.9
12 Merck & Co. Inc. AA 25.8 24.8 (0.7) (1.7)
13 Pfizer Inc. AA 23.0 42.1 (14.3) 3.1
14 The Coca-Cola Co. AA- 22.2 45.7 2.3 1.5
15 Intel Corp. A+ 22.1 25.3 (6.1) 2.6
16 General Motors Co. BBB 21.6 10.8 1.3 2.0
17 Abbott Laboratories BBB 18.8 22.0 12.7 13.0
18 PepsiCo Inc. A+ 16.1 36.9 4.1 3.7
19 Dell Technologies Inc BB+ 15.3 49.4 15.3 49.4
20 Procter & Gamble Co. AA- 13.5 29.5 (0.8) (2.1)
21 Walgreens Boots Alliance Inc. BBB 11.8 18.9 8.2 4.9
22 eBay Inc. BBB+ 11.1 9.0 1.6 2.2
23 Eli Lilly & Co. AA- 10.7 10.3 3.1 2.3
24 General Electric Co. AA- 10.7 20.5 0.1 2.0
25 Boeing Co. A 10.0 10.0 (2.0) 0.0
Total 1,022.3 758.4 131.7 194.0
Year-over-year change 15% 34%

Overseas Cash Hoard Is Near $1.1 Trillion

Most companies don't report their cash holdings by region. But we've found that the top 15 cash holders that do so increased their overseas cash balances by $100 billion last year (see table 2). Cash held outside the U.S. accounted for most of the growth in cash holdings, indicating that these large cash-rich issuers completely exhausted their domestic cash flow and chose to borrow in significant amounts in lieu of repatriation to fund shareholder returns. In all, these 15 issuers now hold 84% of their cash overseas, a significant increase from about 70% in 2012. As for the S&P Global Ratings-rated universe of nonfinancial corporates, we estimate that about 60%, or $1.1 trillion, of the $1.9 trillion is now held offshore.

Table 2
Overseas Cash Vs. Domestic Cash: For the Top 15 Issuers that Report Overseas Cash

(Bil. $)            
Company Rating as of May 22, 2017 Cash and investments Domestic % Overseas % Overseas Total Debt
Apple Inc. AA+ 246.1 15.9 230.2 94% 87.5
Microsoft Corp. AAA 130.1 13.8 116.3 89% 87.8
Alphabet Inc. AA+ 86.3 34.1 52.2 60% 3.9
Cisco Systems Inc. AA- 71.8 9.5 62.3 87% 34.9
Oracle Corp. AA- 59.4 7.2 52.2 88% 53.0
Johnson & Johnson AAA 41.9 0.6 41.3 99% 27.1
Amgen Inc. A 38.1 3.7 34.4 90% 34.6
Gilead Sciences Inc. A 32.8 5.4 27.4 84% 26.3
Qualcomm Inc. A 29.8 1.9 27.9 94% 11.7 Inc. AA- 26.0 20.1 5.9 23% 20.4
The Coca-Cola Co. AA- 22.2 8.5 13.6 62% 25.3
Intel Corp. A+ 22.1 8.5 13.6 62% 25.3
PepsiCo Inc. A+ 16.1 0.9 15.2 94% 36.9
Walgreens Boots Alliance Inc. BBB 11.8 10.2 1.6 14% 18.9
eBay Inc. BBB+ 11.1 2.9 8.2 74% 9.0
Total 845.6 136.7 708.9 84% 523.2

Tax Reform Is A Game Changer

Tax reform, specifically regarding repatriation, is of particular interest to S&P Global Ratings, given that we apply our surplus cash criteria to calculate debt when measuring credit metrics. Therefore, repatriation and the subsequent distribution of cash to shareholders could affect our adjusted credit ratios--although the effects on ratings would depend on each specific case and whether this represents a change in a company's financial policy. If we were highly confident that impending tax reform would lead to a change in a company's financial policy, we could incorporate these views into our existing financial policy assessments and forward-looking forecasts. While tax reform, in both specificity and timing, remains uncertain, we believe there is enough support among various constituents that some sort of reform facilitating the repatriation of overseas earnings is likely to become a reality in the next year or so.

In such a scenario, we believe most companies would repatriate meaningful amounts of overseas cash, largely for share repurchases, but also for acquisitions and some debt repayments. (See "Credit FAQ: What Impact Could Cash Repatriation Have On U.S. Corporate Credit Quality?" published Feb. 13, 2017 on RatingsDirect.)

Repatriation Will Have Major Impact On Technology

With its total cash holdings in excess of $800 billion, up to three-quarters of which we estimate may be held offshore, the technology sector stands to be affected most by repatriation. If tax reform is passed, we expect borrowers to immediately bring cash home, although the pace of repatriation will depend on each company's needs and the timing of tax payments due. More important, we expect an orderly distribution of excess capital, which we believe would be communicated to investors well in advance of actual repatriation.

Specifically, we expect share repurchases will increase significantly, although this would take place over multiple quarters, if not years, depending on the size of the cash position and repurchase authorization. Dividends would also likely increase, through both one-time special dividends and dividend hikes. While we don't think that mergers-and-acquisitions strategy will change meaningfully, given that most issuers have had access to credit markets for strategic takeovers, we note that borrowers would have greater strategic flexibility with cash onshore.

As for debt, we believe that some companies (mostly large, cash-rich companies) would set aside cash to pay off debt or meet upcoming maturities. Debt outstanding in the technology sector has grown significantly in the past five years, much of it through synthetic cash repatriation. In fact, Apple, Microsoft, Cisco, and Oracle alone were responsible for more than $100 billion of new debt issuance in 2016, a 10-fold increase from just five years ago (although part of Microsoft's debt issuance was attributed to its acquisition of LinkedIn). We believe borrowing among large technology companies may slow once cash is repatriated. As companies become more certain of the probability of tax reform, some may increase their use of commercial paper (CP) as a short-term measure, until they can pay down debt with repatriated cash.


Health Care May Face Shareholder Pressure

The health care sector has the second-highest amount of overseas cash after the technology sector, much of the cash with pharmaceutical companies. While we believe that tax reform is a major long-term positive for the industry, we believe the ratings may be at risk over the near term given the increased possibility of shareholder-friendly actions that may drain the cash balances. Pharmaceutical companies have a range of options, including holding onto the cash, repaying debt, boosting research-and-development and capital expenditure, repurchasing shares, and paying dividends. We believe each company will likely do a combination of the aforementioned options, the mix of which will depend on each individual company and the financial aggressiveness of its management team.

We believe there will be some debt repayment and holding of cash onshore, but absolute debt levels at pharmaceutical companies are likely to decline only modestly given the still low-interest-rate environment.

We expect the pace of acquisitions to slightly increase in the pharmaceutical sector after tax reform. While acquisitions were down in 2016, the sector set a record pace for acquisitions over the past three years, as companies sought to diversify their pharmaceutical portfolios and deepen their prospect pipelines in the face of unprecedented pricing pressure from consolidated payers. That said, pharmaceutical companies have had more than adequate access to capital to fund acquisitions, so repatriation alone isn't enough to drive increased acquisitions. However, an increased number of attractive U.S.-based pharmaceutical assets could, in a post-tax-reform world, satisfy companies' internal return hurdles and lead to increased bidding.

Increased shareholder-friendly actions appear the most likely uses of the repatriated cash, although the size and likelihood of such activities will depend on each company and what level of shareholder pressure it is under to generate growth in the increasingly competitive pharmaceutical sector. Companies such as Gilead and Amgen, which both sit on over $30 billion of overseas cash and face slowing growth, may face shareholder pressure, and we would not be surprised should activists emerge to pressure select pharmaceutical companies. Indeed, ahead of tax reform, we may see pharmaceutical companies' net leverage start drifting up, as companies delay repatriation and issue more, potentially shorter-term, debt and increase CP utilization to fund operations while awaiting repatriation. Also, should tax reform become an increasing reality, pharmaceutical companies may increase share repurchase activity ahead of tax reform in anticipation.

Repatriation's Credit Impact Will Be Neutral To Negative

S&P Global Ratings views repatriation as a potential credit risk if issuers were to become more aggressive in their shareholder returns than what we assume in our forecasts and assessments of financial policy. We believe that the improved accessibility to offshore cash under proposed tax reforms could provide both economic incentives and pressure on management to revise its financial policies and capital allocation strategies. The depletion of surplus cash, if not accompanied by similar debt repayments, could raise adjusted leverage and, in turn, pressure credit metrics. While some borrowers could maintain similar levels of net cash by offsetting shareholder returns with debt reduction, many others are likely to determine that their large cash (and debt) positions were solely in response to tax constraints, and would no longer see a need to maintain such liquidity.

In all, we see a decline in net cash balances and, with it, rising leverage for some borrowers and reduced cushion for others. Specifically, the top 1% of borrowers alone could repatriate more than $700 billion over time and may return a significant amount of this cash to shareholders (although some cash would almost certainly go to pay down debt or meet upcoming maturities). That said, we don't expect this to lead to meaningful rating actions for the top 1%, as these borrowers would mostly be reducing their cushion with respect to the ratings.

On the other hand, borrowers who are cash neutral or in net debt positions despite having large cash balances--including some in the top 1% and many in the crossover categories of 'BBB' and 'BB'--will have to manage a delicate balance between equity holders and debtholders. If a borrower with limited ratings cushion opts to use most of the repatriated cash for repurchases, thus raising leverage per our calculation, we may review the company for a potential downgrade.

2017 May Mark The End Of Cash Hoarding

Cash growth among U.S. corporates has been a popular topic among investors over the past decade. It is a story of American economy's resilience, a tax policy that encouraged borrowing instead of repatriating, and a reflection of the growing divide between the haves and have-nots. As the cash on U.S. corporate balance sheets nears $2 trillion, we may be nearing the peak of the great cash hoarding. Simply put, we can't see U.S. companies continuing to build up cash at the current rate if tax reform facilitates the repatriation of foreign earnings.

Credit market conditions have been favorable for a long time, but leverage is near post-crisis highs and the credit cycle is aging. This raises the question of whether a decline in cash balances would be matched by an unwinding of debt.

We expect that most investment-grade borrowers and those at the stronger end of the speculative-grade spectrum will be able to adjust their operational and financial policies to absorb an expected steady climb in interest rates. But if access to capital markets becomes fragmented, liquidity risk could increase, especially for borrowers at the lower end of the ratings scale--in other words, those that can least afford it.

Given the dislocation in capital markets that occurred in 2008 and 2009--as well as the volatility we saw at the beginning of last year--we wouldn't be surprised to see some wariness among investors. Against this backdrop, future financings--particularly for borrowers in stressed sectors--could be at risk.


The cash and investment figures referred to in this report include cash, short-term investments, and long-term liquid investments for nonfinancial corporate issuers rated by S&P Global Ratings at each year end. Unlike in prior years, cash and debt figures mentioned in this report exclude regulated utilities, as they are not considered part of S&P Global Ratings' corporate ratings. The report excludes issuers domiciled overseas who issue debt in the U.S. The report also excludes debt related to captive financing companies owned by issuers. We have made certain assumptions in an attempt to approximate overseas cash for the purpose of this analysis due to disclosure limitations.

S&P Global Ratings' Global Outlook 2019

 A deep dive into S&P Global Ratings’ insights on the credit outlook for 2019 and what are the risks and vulnerabilities to look out for.

Access all the Global Outlook
Read More

How Management & Governance Risks and Opportunities Factor Into Global Corporate Ratings


An assessment of management and governance is part of every corporate issuer rating.

We find that events of mismanagement and poor governance contributed to severe multiple-notch downgrades.

Notable cases of key personnel misconduct, bribery, data breaches, and corporate criminal behavior have been captured in our ratings analysis. We highlight some here.

In total there were 262 instances over a two year period where we reassessed our M&G score. Over 60% related to a negative reassessment, while the rest were positive.

S&P Global Ratings has completed a two-year review of how issues of management and governance (M&G) are reflected in our ratings. For that period, we found 77 cases where a revision of our view of management and governance factors led to rating changes, and a total of 262 cases where these factors were a part of the analysis and resulted in a change of our management and governance assessment.

We consider M&G factors explicitly in every corporate issuer credit rating. Our M&G criteria encompasses a range of factual and qualitative assessments that we apply and revise as necessary based in part on our in-person meetings with management as well as our understanding of how governance impacts credit quality more broadly.

This analysis looks at the universe of rated corporate entities and transitions of their M&G scores from July 2015 to August 2017. We have complemented the analysis of our scores with the application of a natural language processing technology highlighting some other notable instances of M&G factors considered elsewhere in the rating analysis. Finally, we have selected a number of past rating actions to illustrate our analysis of various governance factors.

This report is part of a series covering the impact of environmental, social, and governance (ESG) factors in our credit ratings. In October 2015, we published our first review of how environmental and climate factors affected our ratings between 2013 and 2015 (“How Environmental And Climate Risks Factor Into Global Corporate Ratings,” Oct. 21, 2015); last November we conducted our second (“How Environmental and Climate Risks and Opportunities Factor into Global Corporate Ratings – An Update,” Nov. 9, 2017). We then expanded the series to review social factors (“How Social Risks and Opportunities Factor Into Global Corporate Ratings,” April 11, 2018). These reports showed that environmental and climate factors contributed more frequently than did social factors over the same period, and that while environmental and climate factors affected ratings in a nearly even split of negative to positive, social factors were overwhelmingly negative in terms of impact on credit quality. We will continue to track how we incorporate ESG risks and opportunities into our credit analysis, and we plan to further report on how those factors may affect entities' creditworthiness.

Governance in Ratings Processes

Our view on management and governance could significantly influence credit factors other than solely the M&G assessment, such as a company's competitive position, its credit metrics, and our view of its financial policy, each of which, on its own merits, can have direct impacts on the issuer rating.

An effective management team may, in times of market duress, seek to balance the needs of debtholders with those of shareholders by making efforts to reduce leverage. By contrast, a management team could be excessively focused on pursuing debt-funded mergers and acquisitions (M&A); while growth is part of every company's strategy, it can become a governance issue if it involves excessive risk-taking or results from skewed management incentives causing a misalignment between management's interest and that of debt- or shareholders.

This illustrates another aspect of the governance analysis: while management can actively take actions that worsen credit quality, it can also fail to take actions that would support credit quality. This duality is part of the reason why management meetings, which are part of every rating, are of such importance. Management teams have a finite level of resources that can be dedicated to mitigating risk; our interactions with them indicate which are of the highest priority, and this selection can influence credit quality.

Relevance and definition

Sudden management and governance developments can often have an immediate or future impact on an issuer's creditworthiness, and weak policies or structures can often be red flags that herald adverse credit developments. Among actions and behaviors that could impact an M&G assessment are matters like:

 - Executive/board and auditor departures and changes (particularly when sudden, unexpected, and repeated) can herald changes in strategic direction, indicate management dysfunction, or presage accounting, legal, or regulatory problems or operational underperformance.
 - Delayed financial reporting or a qualified audit report can be a signal of underlying performance issues. Even if resolved, it often is accompanied by reduced access to capital.
 - Lack of in-depth involvement by the board and/or its owners of management's strategic plans or complex areas of operations reduces their effectiveness to oversee risks.
 - Badly-designed management compensation (with excessive focus on short-term results and pay-out) or ineffective compensation or audit committees can cause excessive risk-taking and/or damage the long-term sustainability of the company.
- The presence of activist investors. While their presence is not invariably negative for credit quality, they can also prompt or signal change in an issuer's strategic direction, risk appetite, and the potential for personnel changes to board and management, often at the expense of debtholders.

Our working definition for management and governance, as reflected in our M&G criteria, "encompasses the broad range of oversight and direction conducted by an enterprise's owners, board representatives, executives, and functional managers. Their strategic competence, operational effectiveness, and ability to manage risks shape an enterprise's competitiveness in the marketplace and credit profile.

"If an enterprise has the ability to manage important strategic and operating risks, then its management plays a positive role in determining its operational success. Alternatively, weak management with a flawed operating strategy or an inability to execute its business plan effectively is likely to substantially weaken an enterprise's credit profile."

Process and criteria

As shown in table 1, our M&G score is an amalgamation of assessments. We assess eight "Management" factors relating to strategy, risk management, and organizational effectiveness, each of which we score positive, neutral, or negative.

We also assess seven "Governance" factors, which are each scored as neutral or negative. In a circumstance when a governance deficiency or deficiencies impairs the ability of the enterprise to execute strategy or manage its risks, can be labelled severe.

These 15 factors are aggregated into the management and governance assessment, which can result in a strong, satisfactory, fair, or weak score. The result of the management and governance score, combined with certain anchor ratings, can result in increase on that rating of up to one notch, or a decrease of two or more notches, as shown in table 2. Sometimes these adjustments are only triggered if we feel we have not already captured the benefits of strong management and/or governance in the business risk profile or financial risk profile.

Each of the seven governance factors is primarily concerned with the structures and systems a company has in place that govern how it operates strategically (or not) given the various regulatory, political, economic, social, and natural environments it operates in. The governance systems are ultimately in place to guide, advise, and at times intervene in management's actions and planning to ensure the company's growth and longevity. Unlike the management factors that can be scored positively, governance factors are scored neutral or negative, and serve as an overarching scoring indicator when the two are combined. The rationale is that management cannot manage to optimum performance if the governance structures and systems are not in place that allow them to do so. This is reflected in the criteria, which caps the overall M&G Score at fair with just one governance negative subfactor, even if there are many positives among the management factors.

Table 1

Countdown to Brexit: No Deal Moving Into Sight


The risk of a no-deal Brexit, while still not our base case, has increased sufficiently to become a relevant rating consideration, reflecting the inability thus far of the U.K. and EU to reach agreement on the Northern Irish border issue.

Economics: A no-deal Brexit could push the U.K. economy into a moderate recession and lower the economy's long-term growth potential. Most of the economic loss of about 5.5% GDP over three years compared to our base case would likely be permanent.

Sovereign: Our economic, fiscal and debt, and external assessments would come under pressure in the event of no-deal and the U.K. sovereign ratings are likely to be lowered.

Corporate: Contingency plans are unlikely to insulate companies fully from market volatility, legal and regulatory uncertainty, border delays, rising input costs and tariffs, and weakening competitiveness and operating performance in many sectors.

Financial institutions: U.K. banks will likely be the most vulnerable in a no-deal Brexit.

Structured finance: Potential operational and counterparty risks from a no-deal Brexit may be significantly higher than the credit risk of the securitized assets if counterparties can no longer perform on existing contractual arrangements, in particular if this leads to the termination of derivative agreements.

Insurance: While insurers have been planning for post-Brexit business continuity, negative rating pressure would likely result from any downward revision to the U.K. sovereign rating, economic downturn, financial market volatility, or material operational challenges.

U.K. public sector: About half of social housing providers would likely suffer negative rating pressure if real estate prices declined consistent with our no-deal Brexit scenario.

When it voted to leave the EU in the June 2016 referendum, the United Kingdom decided against "business as usual" with the EU. As a result, the U.K.'s business model will change, but at this point, it is still uncertain when this change will happen and how significant it will be.

Our base-case economic forecasts assume that the U.K. and the EU will agree and ratify a Brexit deal, leading to a transition phase lasting through 2020, followed by a Free Trade Agreement (FTA). But given our increasing doubts that the U.K. and EU will agree to the terms of a Withdrawal Treaty required to facilitate a 21-month status-quo transition, we see an increasing risk that the U.K. will secede from the EU and, importantly, the EU single market, without any deal at the end of March 2019. This would constitute an abrupt and very significant change to the U.K.'s business model overnight, although policy measures might soften the short-term blow to the U.K. economy.

In a no-deal Brexit, the U.K. would become a third country from the EU's perspective, reverting to World Trade Organization (WTO) rules for goods trade not only with the EU, but also with third countries currently covered by EU Free Trade Agreements (FTA), such as Canada, together affecting around 65% of U.K. goods exports. A no-deal Brexit would also mean a lapse of EU regulatory recognition of U.K. rules in many areas, including financial services. Even U.K.-issued credit ratings might not be usable in the EU absent a deal. The U.K. might also be required to create regulatory supervisory procedures to substitute for those currently conducted by the EU.

This report analyzes various economic and credit-related implications of such a no-deal Brexit scenario for entities we rate in various sectors from a U.K. perspective, even though we would expect also some negative, albeit lesser, impact for other exposed EU economies and companies.

What No Deal Could Mean To The U.K. Economy

Key Takeaways

 - A no-deal Brexit could push the U.K. economy into a moderate recession, representing a cumulative loss of about 5.5% GDP compared with our baseline forecast over 2020-2021. Although severe, this projected loss is still only about 60% of that caused by the 2008 financial crisis.
 - The U.K.'s direct loss of trade globally could amount to 1.9% of U.K. GDP over the scenario horizon.
 - Regulatory and infrastructure challenges, lack of investment, trade bottlenecks, and lower immigration would push down the U.K. economy's long-term growth potential.
 - As a result, we believe it likely that the U.K. economy would have limited scope to emerge from this moderate recession and regain pre-Brexit output levels over the next three years.

In our no-deal scenario, the U.K. would experience a moderate recession lasting four to five quarters, with GDP contracting by a cumulative 2.7% over two years, after which the economy would return to growth, although the pace of growth would be moderate. By 2021, economic output would still be 5.5% less than what would have been achieved had a deal been struck and a transition occurred. Unemployment would rise from current all-time lows of 4% to above 7% by 2020 (a rate last seen in the aftermath of the financial crisis). House prices would likely fall by 10% over two years.

How A No-Deal Brexit Could Unfold

In our scenario, the short-term impact would start with a fall in share prices, a rise in corporate borrowing costs, and a further substantive weakening of sterling in the first quarter of 2019, even before the end of March 2019 as markets start to discount a no-deal Brexit. Significant disruption and further market volatility could then ensue, following the no-deal Brexit. In a set of technical notes, the U.K. government has identified key stress points, including transport, customs, financial and insurance contracts, and medicine supply. However, the economic consequences of these disruptions is uncertain. These consequences will also depend in part on the effectiveness of preventative measures taken by the U.K. and EU. We expect both the U.K. and the EU will try to limit disruption, at least in critical areas, such as customs and transportation. We do, however consider it almost certain that most goods shipments would be delayed. This would in particular affect U.K. sectors with supply chains that are heavily integrated with the EU.

Moreover, in a no-deal Brexit the U.K.'s financial sector would immediately lose financial passporting rights, which we estimate would directly cost the U.K. economy, without considering second- and third-round effects, about 0.4% of GDP per year. These direct costs are relatively moderate, partly because financial institutions have already been preparing for this case. The most immediate concern for the financial sector would be the serviceability of certain derivatives and insurance contracts. If required, the Bank of England (BoE) and the European Central Bank (ECB) would likely also introduce measures to mitigate financial stability risks.

Given our expectation that sterling will depreciate by 15% initially and that WTO import tariffs will apply to imports from the EU and countries covered by EU FTAs, inflation would likely rise: we see it peaking at 4.7% in mid-2019. Similarly, the EU would impose tariffs. As a result, goods exports from the U.K. could be an estimated 1.9% of U.K. GDP less than in our baseline forecast, although the weaker sterling exchange rate would offset the impact somewhat by making U.K. goods cheaper to import abroad.

We also expect that the BoE would likely see through temporarily higher inflation by cutting its policy rate to zero. It might not be necessary to relaunch a full-fledged quantitative easing (QE) program, in our view. The share of foreign investors in U.K. Gilts (treasury securities) is relatively low (28%) and, more importantly, it has not declined following the referendum. U.K. sovereign debt also has much longer average maturity than that of many peer countries. Rather than a full QE we believe the BoE might deploy a form of QE that specifically targets corporate bonds. As businesses adapt to the new and weaker business environment, many would need to cut costs, including by letting workers go. We expect that the U.K.'s unemployment rate could rise to above 7% by early 2020. The weaker business environment will also likely mean weaker wage growth and, along with higher inflation, real wages could fall for at least a two-year period, weighing substantially on consumer spending. We estimate that household income could decline by £2,700 per year on average over 2019-2021. Declining household spending and weaker demand would also, by 2021, lead to significant house price declines, ending up 15% below the levels that we expect in our base-case forecasts. We expect a moderate decline in fixed investment spending as the government would need, in our view, to increase its own investment spending to cope with a no-deal Brexit. Businesses will also need to spend on Brexit-related investment. Public sector recruitment levels would also likely need to rise, which would offset some decline in household incomes.

Regarding the assumption of certain regulatory responsibilities by the U.K. authorities, we expect that these authorities' capabilities and efficiencies will develop over time. We expect that certain physical and digital infrastructure will need to be developed rapidly to cope with the new post-Brexit reality. Some of the current supply chains would likely be impaired and require reorganization. These factors, in conjunction with lower net immigration and contraction of investment spending, would translate not only into lower economic potential of the U.K. economy, but also lower trend growth. This latter feature is important, as it is key in determining how much and how quickly the economy might be able to recover from a no-deal Brexit. In our scenario, we project that the effects of a no-deal Brexit will likely extend at least to our three-year forecast horizon. Incidentally, a slowdown in trend growth was a key reason why the U.K. economy was thrown onto a lower growth trajectory following the global financial crisis: the impairment of the financial system, which is a crucial part of market infrastructure, had negatively affected the economy's operating capacity.

China Inc. Will Struggle to Stay on the Deleveraging Path


China Inc. will find it hard to maintain the current two-year deleveraging trend.

The median debt-to-EBITDA ratio improved to 3.3x in 2017, from 3.6x in 2016 and 3.8x in 2015.

State-owned upstream sectors deleveraged the most last year, due to supply-side reforms and continued price reflation.

In this year's survey of China's top companies, real estate surpassed oil and gas to be the third largest sector by total debt.

As per previous surveys, private-sector companies demonstrated more capital efficiency and stronger financials.

China's top 254 corporates have an overall business risk profile that we classify as fair and a financial risk profile of intermediate.

Our assessments map the portfolio to an anchor of 'bb+', compared with 'bbb' to 'bbb-' last year.

The weakening profiles reflect our forward-looking views, as well as our wider coverage of companies in this year's sample. This year we added 34 companies and two new sectors.

Our expectation of a pause in deleveraging is based on tougher credit conditions amid "shadow banking" reform, and slower earnings growth off a heightened base.

China's top companies will likely veer from the deleveraging path this year. S&P Global Ratings believes the slippage will come from slowing earnings growth rather than excessive outlays or borrowing. Overall we expect capital spending to remain more disciplined, setting the stage for China Inc. to eventually resume the major undertaking of reducing its debt burden.

After two years of improving debt to income, corporate balance sheets are in better shape to face potential economic headwinds brought by subsiding reflation and trade rifts. State-owned enterprises (SOEs) in upstream sectors have led improvements in capital discipline, under the close watch of state reformers. Property companies, on the other hand, have only recently begun to hem in debt-fueled expansions, partly in response to tougher financing conditions.

We expanded our survey this year, which brought some smaller and riskier companies into the mix. Overall, our portfolio of 254 companies represent the biggest players in their respective sectors.

In 2017, financial metrics improved for the second consecutive year, but business and financial risk profiles weakened. This is because our assessments are forward-looking. The deterioration also reflects our wider portfolio.

Who's Who In The Top Corporates?

Our 2018 study of China's top corporates includes 254 entities from 21 industry sectors. We added two new sectors. To improve coverage, we add chemicals with seven companies. We added package express to capture the rising importance of this sector in the consumer economy and online consumption over the past few years.

There is a net increase of 34 companies compared with last year, focusing mainly in capital goods (eight new companies), chemicals (seven), technology hardware (five), and consumer (five). The changes reflect China's positioning in the global supply chain, as well as the domestic economy's continuous shift to a consumption-led economy.

The portfolio for this study extends beyond our rated China universe. The number of rated entities make up one-third of the composition, similar to last year.

SOEs still dominate China Inc.

The constituents selected are leading or the largest borrowers in their industry. SOEs comprised 63% of the sample, slightly lower than last year. The declining trend in SOE composition should reflect the wider participation of private enterprises in the economy and rising services sectors.

We believe our sample has meaningful representation to gauge the financial health of "China Inc." As a group, the top 254 corporates (including infrastructure) account for 17.8% of the total borrowings of nonfinancial companies in China.

The SOEs dominate sectors that are strategic to China's national interests. These include energy (oil and gas, utilities, mining), infrastructure (telecommunications, transport, railway and metro), and engineering and construction. Companies in strategic sectors have a dual role: to support the state's policies in economic and social development, and maintain a reasonably healthy financial profile to execute these roles.

The areas in which SOEs are financially stronger than private enterprises usually have high barriers to entry due to policy or legacy reasons, a highly concentrated market, or special operating rights. These sectors include telecommunications, oil and gas, and electricity grid operators.

A good representation across sectors

For this year's survey, most represented sectors have at least five companies. The exceptions include telecommunications, which has only four operators. Both oil and gas and media entertainment also have only four companies. S.F. Holding Co. Ltd. and four delivery companies, were reclassified from transportation to the package express sector.

In terms of sheer number of companies, consumers (retail and goods) continue to be the largest sector in our survey, followed by capital goods and utilities. Each of these three sectors account for at least 10% of the total sample size.

In terms of assets size, the capital-intensive industries of utilities, railway and metro, and oil and gas dominate (see chart 1). On the debt front, utilities and railway and metro together account for about 40% of the sample's total borrowings (see chart 2).

China Railway Corp. (CRC), the commercial arm of the former Ministry of Railways, is the largest borrower in our sample and accounts for 19% of the total debt of sample corporates.

In this year's survey, real estate surpassed oil and gas to be the third largest sector by total debt, reflecting the aggressive expansions by property developers. In contrast, major state-owned oil operators followed the government's deleveraging initiative. As such, they demonstrated more disciplined control over debt growth.

In our analysis, we have used median rather than averages to gauge the credit metrics for each sector and for the sample. This removes the impact of the size of a company and outliers.