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.

Overview

• 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

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

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.

Methodology

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.