September 24, 2023

Blue-Chip debt troubles are just getting started: Credit Weekly

(Bloomberg) — The corporate bond market now seems surprisingly blasé about the risk of an economic downturn.

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US job growth is slowing and consumer spending looks increasingly sluggish. While top U.S. companies remain generally healthy, some early signs of trouble are emerging, including rising costs and pressure on profit margins, Citigroup analysts, including Daniel Sorid, wrote this week.

So far, investors haven’t necessarily factored that in. Growing demand for global blue-chip debt has pushed the extra yield it pays against government bonds, or spreads, to the lowest level since March, when the US regional banking crisis ravaged global credit markets.

“The rate hikes that the economy is digesting will be reflected in the profit and loss statements of investment-grade companies,” said David Knutson, senior investment director at Schroders Plc. “The economy will continue to slow gradually, and a slowing economy generally means wider spreads.”

Any downturn would be painful for companies that have accumulated huge amounts of cheap debt in recent years. As companies refinance, those loans threaten to become a millstone. More than $500 billion in bonds rated BBB, or two steps above junk status, are at risk of downgrade globally, according to an analysis by Bloomberg Intelligence last month.

Weaker stats

“Cash flow metrics and margins were weaker in virtually all industries,” said Joel Levington, director of credit research at BI, after it assessed nearly 1,450 issuers. “If business trends continue, you get weaker leverage metrics like debt/Ebitda. And that can have consequences for the viewing figures.”

As more companies are downgraded to junk status, existing companies with speculative credit ratings will also have a harder time raising cash, potentially leading to an increase in defaults.

UBS Group AG forecast last month that defaults in leveraged loans and junk bonds will hit 8% and 6% respectively by early 2024.

Even executives at investment-grade companies appear to be gearing up for a turnaround in the economy. Citigroup analysts point out that buybacks as a percentage of earnings before interest, taxes, depreciation and amortization are already falling, as are dividends when compared to the same metric.

More conservative

“The trends in capital returns to shareholders suggest that IG companies are becoming more conservative with their use of cash ahead of a potential recession,” the analysts wrote.

Others are more positive about the outlook. “The well-teled impending recession that has yet to materialize has led many companies to remain conservative with their growth plans and balance sheets, putting them in a better position than we would normally see late in the cycle,” said Travis King, head of USInvestment. corporates at Voya Investment Management.

Still, Apollo Global Management Inc. economist Torsten Slok points to an increase in recent weeks in the number of companies with obligations of $50 million or more seeking bankruptcy protection as a sign that the default cycle in the broader credit market may have begun.

“Maybe the rate hikes are starting to come through,” he said, adding “the Fed is succeeding in slowing the economy.”

Week overview

  • Private equity firms must reduce leverage on buyouts to close deals, hoping to add more debt later.

  • Private lending firms, which have shaken the financing markets by snatching buyout debt deals from Wall Street, are now changing the landscape in part of the $1.3 trillion CLO business.

  • Bonds backed by auto loans are heading for their first loss since the 1990s as Americans fall into arrears and dealerships collapse.

  • ESG funds piled into green bonds sold by Thames Water Plc are trying to figure out what the environmental, social and governance catastrophes that threaten the utility’s future mean for their interests.

  • Rallye SA, the holding company that controls troubled grocer Casino, faces a fine of €25 million ($27.2 million) after French market regulators accused it of artificially inflating its share price by being deceptive about access to cash.

  • Dollar bonds from state-backed builder Sino-Ocean have nearly halved in a week following news that shareholders had set up a task force to examine the debts and hired a financial adviser.

En route

  • Wells Fargo & Co. has hired two high-yield salespeople from Credit Suisse Group AG, Brian Harris and Emma Bramson.

  • Teresa Debenedictis, saleswoman of UBS Group, has left the Swiss lender after working there for more than 25 years.

  • Royal Bank of Canada corporate credit merchant Adam Russell has left the bank, while three new hires have joined the European debt capital markets team, including Alex Ulrich and Eugen Eichwald in Frankfurt.

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