US companies unwind cash buffers as economy recovers, default risk eases

U.S. companies are reducing the liquidity cushions they built up in 2020 as improving revenues and low borrowing costs reduce the likelihood of defaulting from a pandemic-era peak.

The median cash ratio of investment-grade rated U.S. companies fell to 29.4% in the first quarter of 2021 from a pandemic peak of 34% in the third quarter of 2020, according to the latest data from S&P Global Market Intelligence. The median cash ratio is a closely watched measure of liquidity that compares a company's cash and cash equivalents to its current liabilities. For lower-rated non-investment-grade companies, the median cash ratio fell to 45.7% from 49.3% in the previous quarter.

Following a dash for cash in March 2020 as the COVID-19 pandemic hit the U.S. and threatened corporate revenues, default risks for corporate America have receded on the back of a recovering economy. Just 11 U.S. companies rated by S&P Global Ratings defaulted in the second quarter of 2021, the lowest total since 2018. Meanwhile, the 121 ratings upgrades for U.S. companies during the period represent a record quarterly increase.

Holding cash on the balance sheet is an inefficient way to use capital, and companies will likely use their surplus liquidity in more productive areas such as investment, or returning capital to shareholders, now that the immediate threat to revenues from the pandemic has largely passed.

"It's an anomaly that they are this high, and that is obviously because of what has gone on in the last 12 months," Viktor Hjort, global head of credit strategy at BNP Paribas, said in an interview. "When you're faced with a huge amount of uncertainty, you dig a moat around your business, and when uncertainty comes down you don't need it anymore."

High liquidity but falling

The measures of liquidity remain far higher than their pre-pandemic levels. For investment-grade companies, the cash ratio is still 10.1 percentage points higher than the pre-pandemic level of 19.3% in the fourth quarter of 2019, while for non-investment-grade companies, the difference is 17.8 percentage points.

And companies have continued to issue bonds at high levels. Investment-grade corporate bond sales totaled $774.94 billion in the first six months of the year, the second-highest total after 2020's record run.

The justification for issuance has changed from a need for cash to refinancing debt at low borrowing costs. The yield-to-worst — the lowest possible yield — for the S&P U.S. Investment Grade Corporate Bond Index was 1.77% on Aug. 2, lower than the 2.78% at the start of 2020, before the pandemic rocked the U.S.

Cheap financing also is being used by companies to fund expenditures such as share buybacks, capital expenditure and mergers and acquisitions.

Share buybacks rebounded to $178.1 billion in the first quarter of 2021, according to data from S&P Dow Jones Indices. The total is just more than double the recent low point in the second quarter of 2020 when many companies scrapped buyback programs in favor of protecting cash flow. But it is still down 10.4% from the pre-pandemic volume in the first quarter of 2020.

"Both the profit and loss and balance sheets are expanding, helped by the largest nominal profit boom since the 1950s," Sean Darby, global equity strategist at Jefferies, said in an email.

The improvement to the balance sheets also offers shareholders the opportunity to gain from either higher dividend disbursements or share buybacks, Darby said.

Sectors unwind at different speeds

The median cash ratio of investment-grade real estate companies fell to 45.6% in the first quarter, from a peak of 104.9% during the pandemic. The ratio is higher than 20.5% in the fourth quarter of 2019.

The median ratio for non-investment-grade rated consumer staples companies fell to 21.4% in the first quarter, close to the pre-crisis level of 20.3%. It jumped to a peak of 50.6% in the first quarter of 2020.

Other sectors have been slower to normalize. At 57.4%, the median cash ratio for non-investment-grade consumer discretionary companies remains close to the 2020 peak of 60.5%, far higher than the pre-crisis level of 31.9% in the fourth quarter of 2019.

In the case of information technology, which has lowered its median cash ratio more slowly than other sectors, earnings are so strong the companies cannot spend the cash quickly enough.

"Apple Inc., Alphabet Inc. and Microsoft Corp. smashed expectations, revealing enormous increases in revenue in their latest fiscal quarters," Adam Vettese, analyst at multi-asset investment platform eToro, said in an email, noting "their 'fortress' balance sheets allow for increased dividends and share buybacks."

Investment-grade information technology companies had a median cash ratio of 53.2% in the first quarter, up from 47.4% in the fourth quarter of 2020 and much higher than the 38.6% ratio at the end of 2019.

Beyond the highly cash-generative IT sector, BNP's Hjort said it is a matter of time before companies normalize their cash ratios.

"After [the financial crisis in] 2009, that process took two years. It's going to be a little quicker this time, but as long as COVID-19 is going on in the background, the corporates might be a bit slow to start that process," Hjort said.