Ratings Ratio Worst Since 2009 as Profits Slow: Credit Markets

Ratings Ratio Worst Since 2009 as Profits Slow: Credit Markets

Corporate creditworthiness in the U.S. is deteriorating at the fastest pace since 2009 with earnings growth slowing as yields rise from record lows.

The ratio of upgrades to downgrades fell to 0.89 times in the first five months of the year after reaching a post-crisis high of 1.55 times in 2010, according to data from Moody’s Capital Markets Group. At Standard & Poor’s, the proportion has declined to 0.83 as of last week from 1 a year earlier.

The Federal Reserve has pumped more than $2.5 trillion into the financial system since markets froze in 2008, helping companies improve profitability by lowering their borrowing costs. Policy makers are considering curtailing $85 billion in monthly bond buying intended to prop up the economy as analysts surveyed by Bloomberg forecast earnings growth of 2.5 percent in the current quarter, the least in a year.“The trend of improving credit quality has slowed as profits are slowing,” Ben Garber, an economist at Moody’s Analytics in New York, said in a telephone interview. “As the recovery matures, companies are liable to get more aggressive in taking on share buybacks and dividends.”

Buybacks, Dividends

Rather than using cash to pay down debt, companies in the S&P 500 Index are attempting to boost their share prices by buying back almost $700 billion of stock this year, approaching the 2007 record of $731 billion, said Rob Leiphart, an analyst at equity researcher Birinyi Associates in Westport, Connecticut.

Borrowers controlled by buyout firms are on pace to raise more than $72.7 billion this year through dividends financed by bank loans, surpassing last year’s record of $48.8 billion, according to S&P Capital IQ Leveraged Commentary & Data.

After cutting expenses as much as they could to improve profitability, companies “will need to see further revenue growth to boost earnings from here,” Anthony Valeri, a market strategist in San Diego with LPL Financial Corp., which oversees $350 billion, said in a telephone interview.

Elsewhere in credit markets, yields on Fannie Mae and Freddie Mac mortgage bonds that guide U.S. home-loan rates rose for a fifth day to the highest since August 2011. The cost of protecting corporate bonds from default in the U.S. fell for the first time in five days. In emerging markets, relative yields narrowed by the most in 11 months.

GE Bonds

Bonds of Fairfield, Connecticut-based General Electric Co. (GE) were the most actively traded dollar-denominated corporate securities by dealers yesterday, accounting for 3 percent of the volume of dealer trades of $1 million or more, according to data from Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The U.S. two-year interest-rate swap spread, a measure of debt market stress, declined 1.6 basis points to 17.65 basis points. The gauge typically narrows when investors favor assets such as company debentures and widens when they seek the perceived safety of government securities.

A Bloomberg index of Fannie Mae’s current-coupon 30-year securities rose 0.05 percentage point to 3.52 percent, up from 2.98 percent on June 18. The average cost of new 30-year, fixed-rate home loans has climbed to 4.51 percent from a record low 3.36 percent in December, according to Bankrate.com data.

Default Swaps

The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark used to hedge against losses or to speculate on creditworthiness, decreased 5.6 basis points to a mid-price of 92.1 basis points, according to prices compiled by Bloomberg. The benchmark had ended June 24 at the highest level since December.

The Markit iTraxx Europe Index, tied to 125 companies with investment-grade ratings, dropped 4.7 to 123 at 9:40 a.m. in London. The Markit iTraxx Asia index of 40 investment-grade borrowers outside Japan slid 13.8 to 164.

The indexes typically fall as investor confidence improves and rise as it deteriorates. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

The S&P/LSTA U.S. Leveraged Loan 100 Index fell for a fifth day, declining 0.1 cent to 97.33 cents on the dollar. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, has declined from 98.88 on May 9, the highest since July 2007.

Leveraged loans and high-yield, high-risk, or junk, bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at S&P.

Downgrades, Upgrades

Relative yields on debt from borrowers in developing countries fell 15 basis points to 380 basis points, or 3.8 percentage points, according to JPMorgan Chase & Co.’s EMBI Global index. That’s the biggest decrease since the index fell 17.5 basis points on July 27, 2012.

Downgrades exceeded upgrades at Moody’s in the first five months of the year, with the New York-based credit rater cutting rankings on 194 U.S. companies and lifting 173. That’s the weakest ratio since the firm cut 632 borrowers and raised 126 in the first five months of 2009 as markets struggled to recover from the failure of Lehman Brothers Holdings Inc.

The long-term ratings of PepsiCo were cut one step to A1 from Aa3 yesterday by Moody’s, which said increasing leverage at the world’s largest snack food maker was inconsistent with its prior grade. Moody’s also reduced the corporate family rating of TransDigm Inc. one level to B2 from B1, citing the Cleveland-based aircraft component maker’s use of a proposed $700 million term loan and a $500 million note offering to finance a dividend.

Sales Slow

S&P, the world’s largest credit rater, has cut 138 U.S. companies this year through June 17 and upgraded 114 companies.

Credit markets have been roiled since Fed Chairman Ben S. Bernanke told Congress on May 22 that the central bank’s policy-setting board could start scaling back purchases of $40 billion in mortgage bonds and $45 billion in Treasuries in its “next few meetings” if the U.S. employment outlook shows sustained improvement. After the Fed’s meeting on June 19, Bernanke said the policy could end entirely by mid-2014.

With yields on 10-year Treasuries at the most in almost two years, corporate borrowing costs have reached 4.28 percent, the highest level since June 2012, according to the Bank of America Merrill Lynch U.S. Corporate & High Yield Index.

Issuance has slowed, following the busiest May on record, as company yields have soared from a record low 3.35 percent on May 2. Bond sales last week of $16.5 billion fell below the 2013 average for the fourth straight period, according to data compiled by Bloomberg.

‘Apprehensive’ Raters

Earnings growth at S&P 500 companies is poised to slow from 2.7 percent in the first quarter and 8 percent in the final three months of last year, Bloomberg data show.

The ratio of cash to total assets for S&P 500 companies stands at about 10.3 percent, close to a record high 10.4 percent reached June 19, Bloomberg data show. The ratio was as low as 5.6 percent in March 2007.

“Companies have done a great job cleaning up their balance sheets but now the focus has moved on to dividends and share buybacks,” Rajeev Sharma, who manages $1.5 billion of fixed-income assets in New York at First Investors Management Co., said in a telephone interview. “That’s what makes the ratings agencies get apprehensive.”

To contact the reporter on this story: Matt Robinson in New York at Mrobinson55@bloomberg.net

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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