Credit Quality Shows Signs of Having Peaked

(Bloomberg) -- In 2022, after the Federal Reserve started raising rates at the fastest pace in decades, some blue-chip US companies vowed to start cutting their debt loads. Those days may be over now. Companies with BBB ratings boosted their share buybacks in the latest quarter for the first time since early 2023, and accelerated their capital expenditure growth after five quarters of slowing, according to Barclays Plc strategists. Dividend growth also accelerated, strategists including Dominique Toublan and Bradford Elliott wrote in a Friday note. Meanwhile, interest expense is rising faster than a key measure of earnings. Add it all up, and it looks like companies are becoming more friendly to shareholders and less so to bondholders. “Although no signs of duress are imminent, it does appear the fundamental picture is likely past the peak for this credit cycle,” the strategists wrote on Friday, with weaker investment-grade companies shifting away from “prudent balance sheet management” and toward shareholder payouts and accelerating capital expenditure. Corporate-bond investors have been snatching up debt all year, sending valuations to near multi-decade highs and leaving spreads on investment-grade corporate bonds close to their tightest since the 1990s. The Barclays analysis underscores how market pricing may be increasingly divorced from the fundamental credit picture. That doesn’t mean a huge selloff is happening soon. Earnings are still relatively strong. Companies at danger of falling into a lower rating tier, so at the equivalent of A- and BBB- credit grades, have generally been cutting debt levels, according to Barclays strategists. For corporate bonds to get much weaker, companies’ financial condition would have to keep getting worse, and demand for the securities would have to drop materially, said Seamus Ryan, director of credit research at GW&K Investment Management. “To see a valuation reset from here, I think we really need a catalyst,” Ryan said. Torsten Slok, chief economist at Apollo Global Management, sees credit fundamentals remaining robust and yields continuing to help draw inflows, he wrote in a note earlier this month. But with valuations already high, particularly for less liquid corporate bonds, it makes sense for investors to switch into either more liquid corporates or less liquid private credit. One reason for the upswing in capex is artificial intelligence, which requires huge investment by utility and energy firms, many of which have a BBB rating. Another probable source of weakening balance sheets is the expected pickup of mergers and acquisitions given incoming US President Donald Trump’s business agenda, with dealmaking likely to increase companies’ leverage. “Signs of animal spirits turning higher are already present,” Toublan’s team at Barclays wrote. “We think next year is setting up to further these trends.” Production note: Credit Weekly will return on Jan. 4. Week in Review On the Move More stories like this are available on bloomberg.com ©2024 Bloomberg L.P.