Credit Quality Shows Signs of Having Peaked

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(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. 

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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. 

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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.   

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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.

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“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

• The Federal Reserve cut rates by a quarter percentage point and said it was slowing the pace of future cutting, sending risk markets reeling. US junk-bond yields reached their highest level since August. High-grade spreads hit their widest level since late November.
• Wall Street firms are debating whether US high-grade corporate bond sales can set a record in 2025, with just over $1 trillion of notes set to mature.
• Private credit firms want more than corporate lending. The largest are laying the groundwork to finance everything from auto loans and residential mortgages to chip manufacturing and data centers in an effort to swell the size of the market by the trillions.
• Hybrid bond issuance in the US reached a record $35.6 billion this year, and strategists predict it will climb 7% to a new high in 2025. These are the kind of bonds CVS Health Corp. sold in early December — they have characteristics of both debt and equity.
• Distressed Hong Kong property company New World Development Co. slid to record lows in credit markets, as concerns mount over its ability to service a debt load that exceeds peers.
• Apollo Global Management said that a booming part of private credit is already a $20 trillion industry and that the market as a whole may reach $40 trillion within the next five years.
• Party City Holdco Inc. is planning to file for bankruptcy possibly within the next two weeks, in a process that may lead to the liquidation of its stores.
• Big Lots Inc. does not expect to complete a planned sale of its business to private equity firm Nexus Capital Management LP, putting the discount retailer that employs more than 27,000 people at risk of liquidation.
• Swiss Re AG, Tokio Marine Holdings Inc., AXIS Capital Holdings Ltd and AXA SA are among providers of $3 billion in credit-risk insurance for the private-sector arm of the World Bank Group, as it seeks to expand its 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 would help the state-controlled rail operator fund maintenance and beef up its infrastructure.

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On the Move

• Blackstone Inc. hired Andie Goh, who was most recently at Ares Management, and Jack Ervasti, who came from KKR & Co., to cover investment-grade deals as the world’s largest alternative asset manager expansion continues its expansion into private credit.
• Barclays Plc has hired Bjorn Andersen, a leveraged loan and high-yield bond banker, from Nordea.
• Former Silver Point Capital managing director Manjot Rana is joining insurer National Life Group to kick-start its private credit offering.
• Credit Agricole SA appointed Olivier Gavalda to replace outgoing Chief Executive Officer Philippe Brassac
• KKR & Co. hired Yoshi Takemoto as a managing director to lead the firm’s Global Wealth Solutions platform in Japan

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