The high-grade bond market in the U.S. already has the lowest credit quality mix since the 1980s, according to CreditSights, and there are signs investors are getting nervous. A Bloomberg Barclays gauge of average corporate bond spreads has surged to a six-month high since since reaching an all-time low in early February.
The big push into the bottom end of high-grade bonds was driven by the search for yield amid record-low rates following the 2008 financial crisis and unprecedented stimulus from central banks. Investors who were comfortable in A-rated bonds moved to BBBs, and those who were comfortable in BBBs dipped into high yield, according to Lyons of CreditSights.
“What happens when that all retraces?” she said.
October 11, 2018: www.bloomberg.com/graphics/2018-almost-junk-credit-ratings/
Bloomberg News delved into 50 of the biggest corporate acquisitions over the last five years, and found:
- By one key measure, more than half of the acquiring companies pushed their leverage to levels typical of junk-rated peers. But those companies, which have almost $1 trillion of debt, have been allowed to maintain investment-grade ratings by Moody’s Investors Service and S&P Global Ratings.
- The vast majority of the 50 deals—valued at $1.9 trillion collectively—were financed with debt.
- This M&A-fueled leveraging of corporate balance sheets contributed to a surge in debt rated in the bottom investment-grade tier and now represents almost half of the outstanding market, Bloomberg Barclays index data show.
“The rating agencies are giving companies too much wiggle room,” said Tom Murphy, a money manager at Columbia Threadneedle Investments. “There’s been some pretty heroic assumptions around cost savings and debt repayments laid out by some borrowers involved in mergers.”
Take Campbell Soup Co. The company borrowed more than $6 billion in the past year to buy Snyder’s-Lance Inc., the maker of pretzels and other snacks. The acquisition more than doubled the company’s debt load to nearly $10 billion, according to data compiled by Bloomberg. The company now has more than 5 times as much debt as earnings before interest, taxes, depreciation and amortization, a measure known as Ebitda, according to Moody’s.
While ratings firms evaluate a number of criteria, a company with leverage that high would be considered junk if judged on that metric alone. For example, two Campbell Soup competitors, Pinnacle Foods Inc. and Lamb Weston Holdings Inc., have lower leverage and are rated below investment-grade. But Moody’s and S&P kept Campbell at investment-grade, saying they expected the merged food company to generate enough revenue to pay down its debt quickly.
Companies have had little reason to keep their credit ratings high during a decade of easy money, as investors worldwide shifted trillions of dollars into riskier bonds in search of higher yields. A company that was looking to borrow debt for seven years would pay just 0.5 extra percentage point in interest annually if it were rated in the BBB tier instead of the A tier, according to Bloomberg data. That amounts to just $5 million more a year for every additional $1 billion the company borrows. In October 2011, that difference would have been almost twice as high.
TL;DR: High levels of corporate debt, low financial incentive to maintain higher credit ratings, and credit rating agencies might be slow with updating the ratings (07-08′ mortgage-backed securities’ credit ratings anyone?).