US non-financial corporations' financial surplus – the difference between their retained earnings and capital spending – rose to 1.1% of GDP in the second quarter, according to flow of funds accounts data released yesterday. Excluding the third and fourth quarters of 2005, which were distorted by a one-off repatriation of foreign profits to take advantage of temporary tax incentives, the surplus was the highest since the fourth quarter of 1960.

The further improvement last quarter reflected a combination of stronger profits, cuts in dividends and fixed investment and faster destocking.

On top of this surplus, corporations raised cash from equity transactions for the first time since the second quarter of 2002, i.e. new issuance exceeded share buy-backs and retirements due to cash take-overs. Meanwhile, bond issuance remained heavy, though down from the record first-quarter pace.

Strong internal cash generation combined with capital market issuance allowed firms to increase their holdings of liquid assets and pay down short-term debt. The ratio of the two therefore rose sharply to its highest level since the end of 2006, supporting hopes of a strong recovery in capital spending – see first chart.

Some commentators have interpreted the recent contraction of bank lending to companies as supply-driven and likely to curtail business expansion. The comprehensive view of corporate finances provided by the flow of funds accounts suggests that bank debt repayment has been voluntary, reflecting the financial surplus and borrowing opportunities in credit markets.

The yield spread of non-investment-grade corporate bonds over Treasuries is inversely related, with a lag, to the sum of the financial surplus and net equity issuance, expressed as a percentage of GDP. The latter last quarter reached its highest level since the second quarter of 1958, suggesting scope for further spread compression – second chart.