Having shored up liquidity with a dash for cash earlier in the year, U.S. companies allowed their cash ratios to decline marginally in the third quarter.
The cash ratio, a closely watched measure of liquidity that compares a company's cash and cash equivalents against its current liabilities, fell for investment grade-rated companies from 34.6% in the second quarter to 34.3%, a level that was still 14.9 percentage points higher than it was in the third quarter of 2019 before global economic lockdowns caused a shortfall in revenues and companies took to credit markets at record levels to bolster liquidity.
For companies rated non-investment-grade, cash ratios have more than doubled in a year, from 24.2% in the third quarter of 2019 to 50.1% in the third quarter of 2020, though that is down from the peak of 51.9% in the second quarter.
Among S&P 500 companies, cash holdings were barely changed in the third quarter, down to $1.88 trillion from $1.89 trillion, according to S&P Dow Jones Indices, confirming that the dash for cash was over amid a recovering global economy, ample central bank support and low borrowing costs.
"Balance sheets have emerged from the pandemic relatively unscathed," Candace Browning, head of BofA Global Research, wrote in a market commentary, noting that "sizable earnings beats this spring/summer suggest that 2021 earnings will exceed 2019 levels."
Deluge of issuance slows
When the spread of COVID-19 initially shook financial markets in March, U.S. companies rushed to bolster their cash buffers, drawing down on revolving credit facilities to the tune of $275.14 billion in March, according to data collected by LCD.
As credit markets settled following guarantees of support from the Federal Reserve, companies switched from drawing down on revolving credit facilities to issuing bonds. Drawdowns fell to $39.21 billion in April and $4.91 billion in May before hitting zero in July and have remained at that level subsequently. By contrast, investment-grade bond issuance surged to record levels in the second half of March and remained high subsequently, topping $200 billion for three consecutive months, a level never previously reached. In the first six months of the year, issuance totaled $1.139 trillion, more than doubling the $564.6 billion total in the first half of 2019.
While significantly higher than the $309.83 billion issued in the third quarter of 2019, at $354 billion issuance had normalized somewhat in the third quarter of 2020, and the $194.1 billion in the fourth quarter so far — only slightly higher than the $182.23 billion a year earlier — confirmed the trend.
It was a similar theme in the non-investment-grade-rated sector, though the dash for cash began later as high-yield spreads took longer to reverse than in the safer investment-grade market. Bond issuance among lower-rated debt peaked at a quarterly record of $130.5 billion in the second quarter, almost double the $72.4 billion total in the first quarter and $71.8 billion in the second quarter of 2019. Issuance has scaled back to $96 billion so far in the fourth quarter, still a significantly higher total than the $75.6 billion total in the fourth quarter of 2019.
Bond issuance is not expected to disappear completely, but now the strategy is not to build liquidity in case of economic shocks such as further lockdowns but to roll over old debt at lower borrowing costs.
"Credit markets are continuing to remain very well supported into the end of the year with economic conditions showing signs of improving, global [purchasing managers' indexes] continuing to print above 50 and positive breakthroughs on the vaccine front providing some visibility on a return to normality next year," Fraser Lundie, head of credit at the international business of Federated Hermes, wrote in an email, noting that "corporate earnings have continued to surprise to the upside and rating downgrades have slowed."
However, the investor class remains cautious. The December BofA fund manager survey found that 44% of respondents wanted companies to prioritize improving balance sheets, making it the most popular use of cash flow. Returning cash to investors through buybacks and dividends was the least preferred option.
Share buybacks have been a prevalent feature of corporate cash spending in recent years but fell sharply as companies prioritized liquidity. Howard Silverblatt, senior index analyst at S&P Dow Jones indices, expects buybacks among S&P 500 companies to total $100 billion in the third quarter. This would be up from $88.7 billion in the second quarter but well down on the $175.9 billion in the third quarter of 2019. Silverblatt expects the pace to ratchet up but only gradually, with $112 billion in the fourth quarter leaving the 2020 total of about $500 billion the lowest annual total since 2013, well down on $729 billion in 2019 and the record year of $806 billion in 2018.
"As vaccinations expand in the first half, the hope is for a second half return of full consumer spending which combined with low interest rates, could trigger higher enterprise spending. This should lead to an increase in buybacks — first for wider option coverage in the first half [of 2021], and then, potentially, for discretionary buying in the second half," Silverblatt wrote in a market commentary.
Of the sectors that had seen their balance sheets significantly impacted by the pandemic, investment-grade companies in the consumer discretionary and information technology sectors experienced the biggest downward quarterly revisions in their cash ratios in the third quarter, from 53.6% to 48.8% and 56% to 51.1%, respectively.
By contrast, energy companies were notable for going the other way with cash ratios for investment-grade companies rising from 22% in the second quarter to 36.5%, though unlike other sectors, this is not a historically high level and is only 1.3 percentage points higher than in the third quarter of 2018.
There was also a jump in the healthcare sector from 50.1% to 56%, though the sector has generally been much less affected, having had an average cash ratio of 40.7% at the beginning of the year before the health crisis struck.
The most affected sector remains real estate — a capital intensive industry that hoarded cash and cut dividends when the crisis struck — with investment-grade companies raising their cash ratios by 7.1 percentage points in the third quarter to 69%. The figure is much lower than at the peak of the crisis, having jumped from 17.3% at the end of 2019 to 99.6% in the first quarter of 2020.
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