Credit Quality Shows Signs of Having Peaked

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(Bloomberg) — In 2022, after the Federal Reserve began raising interest rates at the fastest pace in decades, some major U.S. companies pledged to start reducing their debt burdens. Those days may be over now.

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BBB-rated companies boosted their stock buybacks in the fourth quarter for the first time since early 2023, and accelerated the growth of their capital spending after five quarters of slowdown, according to Barclays Plc strategists.

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Earnings growth has also accelerated, strategists including Dominique Toblin and Bradford Elliott wrote in a note on Friday. At the same time, interest costs are rising faster than the key measure of earnings.

Putting it all together, it appears that companies are becoming friendlier to shareholders and less friendly to bondholders.

“Although there are no signs of imminent duress, the fundamental picture appears likely to pass the peak of this credit cycle,” with weaker investment-grade companies shifting away from “prudent balance sheet management” and toward shareholders, strategists wrote on Friday. Payments and acceleration of capital spending.

Corporate bond investors have been scooping up debt all year, pushing valuations to their highest levels in several decades and leaving spreads on investment-grade corporate bonds near their lowest levels since the 1990s. Barclays’ analysis underscores how market rates can be increasingly disconnected from the underlying credit picture.

This does not mean that a massive sell-off will happen soon. Earnings are still relatively strong. Companies at risk of falling into a lower rating category, equivalent to credit grades of A- and BBB-, have generally been reducing debt levels, according to strategists at Barclays.

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For corporate bonds to become significantly weaker, the financial condition of companies would have to continue to deteriorate, and demand for the securities would have to decline meaningfully, said Seamus Ryan, director of credit research at GW&K Investment Management.

“To see the 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 strong and yields continuing to help attract flows, he wrote in a note earlier this month. But with valuations already high, especially for less liquid corporate bonds, it makes sense for investors to shift either to more liquid companies or to less liquid private credit.

One reason for the rise in capital expenditures is artificial intelligence, which requires huge investments by utility and energy companies, many of which have a BBB rating. Another potential source of weak balance sheets is the expected improvement in mergers and acquisitions in light of incoming US President Donald Trump’s business agenda, with deals likely to increase companies’ leverage.

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“The signs that the animal spirit is rising are already there,” Toblan’s team at Barclays wrote. “We believe next year is poised to reinforce these trends.”

Production Note: Credit Weekly will return on January 4.

Week in review

• The Federal Reserve cut interest rates by a quarter of a percentage point and said it was slowing the pace of future cuts, sending risk markets into a tumble. US junk bond yields reached their highest level since August. High-quality spreads reached their widest level since late November.
• Wall Street firms are debating whether sales of high-quality US corporate bonds could hit a record in 2025, with just over $1 trillion of notes due.
• Private credit companies want more than just lending to businesses. The largest companies are laying the groundwork to finance everything from car loans and residential mortgages to chip manufacturing and data centers in an effort to swell the market into the trillions.
• U.S. hybrid bond issuance has reached a record $35.6 billion this year, and strategists expect it to rise 7% to reach a new high in 2025. That’s the type of bond CVS Health Corp. sold in early December — and it has characteristics Both religions. And fairness.
• Troubled Hong Kong real estate firm New World Development has slumped to record lows in credit markets, with concerns growing about its ability to service a debt load that outstrips its peers.
• Apollo Global Management said the booming segment of private credit is already a $20 trillion industry, and that the market as a whole could reach $40 trillion within the next five years.
• Party City Holdco Inc. plans To potentially file for bankruptcy within the next two weeks, in a process that could lead to the liquidation of its stores.
• Big Lots Inc. does not expect to complete the planned sale of its business to private equity firm Nexus Capital Management LP, putting the retailer that employs more than 27,000 people at risk of liquidation.
• Swiss Re AG and Tokio Marine Holdings Inc. AXIS Capital Holdings Ltd and AXA SA are among the providers of $3 billion credit risk insurance for the World Bank Group’s private sector arm, as it seeks to expand lending in emerging economies.
• Italy’s Ferrovie dello Stato Italiane SpA is set to receive a €2 billion ($2.1 billion) loan from Intesa Sanpaolo SpA, which will help the state-controlled railway operator finance maintenance and strengthen its infrastructure.

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On the move

• Blackstone Inc. Hiring Andie Goh, most recently at Ares Management, and Jack Ervasti, who comes from KKR & Co., to cover investment grade deals as the world’s largest alternative asset manager continues its expansion into private credit.
• Barclays PLC hired Björn Andersen, a leveraged loan and high-yield bond banker, from Nordea.
• Manjot Rana, former managing director of Silver Point Capital, is joining insurer National Life Group to start its own credit offering.
• Credit Agricole SA has appointed Olivier Gavalda to replace outgoing CEO Philippe Brassac
• KKR & Co. Yoshi Takemoto has been appointed Managing Director to lead the company’s global wealth solutions platform in Japan

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