Blue-Chip Debt Problems Are Just Getting Started: Credit Weekly

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(Bloomberg) — The corporate bond market appears to be abruptly cacophonous about the risks of an economic downturn now.

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Job growth is slowing in the US and consumer spending is looking increasingly sluggish. Citigroup analysts including Daniel Soried wrote this week that while US blue chips remain broadly healthy, some early signs of trouble are emerging, including rising costs and pressure on profit margins.

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Yet, investors don’t necessarily price it in. Growing demand for debt from global majors has cut the extra yield you pay on government bonds, or spreads, to the lowest level since March, when the US regional banking crisis hit global credit markets.

“The higher interest rates that are absorbed by the economy will start to show up on the income statements of investment grade companies,” said David Knutson, chief investment director at Schroders plc. “The economy will continue to slow gradually, and a slowing economy generally means wider margins.”

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

weaker metrics

“Metrics of cash flows and profit margins were weaker in almost all sectors,” said Joel Livington, director of credit research at BI, after reviewing nearly 1,450 issuers. “If business trends continue, you will end up with weaker leverage metrics like debt/Ebitda. And that could have implications for valuations.”

More companies being downgraded to junk would also make it more difficult for existing speculative-rated companies to raise liquidity and could lead to a rise in defaults.

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UBS Group AG last month predicted defaults on highly leveraged loans and junk bonds would reach 8% and 6%, respectively, in early 2024.

Even executives at investment-grade companies seem to be preparing for a turnaround in the economy. Citigroup analysts note that buybacks as a percentage of EBITDA are already declining, as is dividend when compared to the same metric.

more conservative

“Trends in returns of equity to shareholders indicate that IG companies are becoming more conservative in using cash ahead of a potential downturn,” the analysts wrote.

Others are more positive about expectations. “The well-telegraphed pending recession that has yet to materialize has resulted in many companies remaining conservative in their growth plans and balance sheets, leaving them in a better position than we typically see late in the year,” said Travis King, US chief investment officer. session”. Tier 1 companies at Voya Investment Management.

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However, the economist at Apollo Global Management Inc. notes: Torsten Slok pointed 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 a cycle of defaults may have begun in the broader credit market.

“Maybe interest rate increases are starting to come,” he said, adding that “the Federal Reserve is succeeding in slowing the economy.”

a week in review

moves

• Wells Fargo & Co. has appointed Two highly productive salespeople at Credit Suisse Group AG are Brian Harris and Emma Bramson.
• Teresa Debenedictis, a loan sales representative at UBS Group, has left the Swiss lender after working there for more than 25 years.
• Adam Russell, a corporate credit dealer at Royal Bank of Canada, has left the bank, while three new employees have joined the European debt capital markets team, including Alex Ulrich and Eugen Eichwald in Frankfurt.

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