Credit market borrowing by US non-financial corporations – encompassing securities issuance and direct loans from banks and others – surged to $901.9 billion at an annualised rate in the fourth quarter of 2012, according to the Fed’s flow of funds accounts. Borrowing was the equivalent of 5.7% of GDP – the highest such proportion since 2007. Bond issuance accounted for $782.0 billion, or a record 4.9% of GDP.

Similar surges in borrowing in the late 1990s and mid 2000s occurred ahead of a significant widening of the yield spread between lower-rated corporate bonds and Treasuries – see first chart.

High borrowing, however, need not imply deteriorating financial health. Bond-holders should worry when fund-raising reflects insufficient internal cash generation, or is used to retire equity. This was the case in the two prior episodes – the corporate “financing gap” between investment and retained profits was large, while the sum of equity buy-backs and cash take-overs far exceeded new issuance.

By contrast, the corporate financial balance is currently in small surplus, i.e. net free cash flow is positive. Above-average equity retirement* is contributing to high credit market borrowing but, in addition, corporations appear to be taking advantage of low bond yields to accumulate financial assets and replace other liabilities.

A superior gauge of economic / financial risk, therefore, is total net borrowing, i.e. the difference between changes in non-equity liabilities and financial assets**. This was 2.3% of GDP in the fourth quarter – far below peaks of 6.8% and 9.2% respectively reached in 1998 and 2007.

Total net borrowing is a more reliable leading indicator of the corporate / Treasury yield spread than the credit market component – second chart. The rising trend in net borrowing suggests that the spread will drift higher in 2013-14 but a dramatic widening is unlikely.

*Equal to 2.7% of GDP in the fourth quarter versus an average since 1985 of 1.8%.

**Calculated here as the sum of the financing gap and net equity retirement.