By Steve Goldstein, MarketWatch
There are some $4 trillion worth of companies at risk if U.S. plans for fiscal stimulus are enacted but don’t significantly boost the economy, the International Monetary Fund warned Wednesday.
The IMF’s global financial stability report finds improving conditions relative to last year’s issue. But the international agency considered what would happen if the U.S. proceeds in tax reform and deregulation.
The IMF considered a situation where there’s a 10-percentage point reduction in effective corporate tax rates, the expensing of new capital expenditures, the removal of the tax deductibility of interest expenses and a one-off repatriation of retained foreign earnings.
Such a move could add more than $100 billion a year in cash flow to S&P 500 firms, and expensing investment and removing interest deductibility would increase cash flow in capital-intensive sectors, such as energy, real estate and utilities. Repatriating liquid assets would give a big lift to the information technology and health-care sectors, where 60% of the $2.2 trillion in unremitted foreign earnings is concentrated.
However, the IMF notes, cash flow from tax reforms may accrue mainly to sectors that have engaged in substantial financial risk taking.
Further, the corporate sector of late has been relying on debt financing. Corporate credit fundamentals have started to weaken, which create the conditions that can precede a credit cycle downturn.
Median net debt across S&P 500 firms is close to a historic high of more than 1.5 times earnings, the IMF says.
And earnings have dropped to less than six times interest expense. Firms accounting for 10% of corporate assets appear unable to meet interest expenses out of current earnings, and firms representing about 20% of corporate assets have slightly higher earnings cover.
Not surprisingly, what the IMF calls “challenged” firms are primarily in the energy sector, owing to oil-price volatility. But real estate and utilities industries also have a number of challenged firms.
“Authorities need to be vigilant to the increase in leverage and deteriorating credit quality,” the IMF said.
While reduced incentives for debt financing could limit a buildup in leverage, a deterioration in interest coverage can still represent a risk, that could lead to losses for banks, insurers, and funds.
“Although there is room to fine-tune existing regulations, policy makers should guard against wholesale dilution or backtracking on the important progress made in strengthening the resilience of the financial system, particularly at a time when balance sheet fundamentals are deteriorating for U.S. companies,” the IMF finds.