Bond Downgrades Escalate With Leverage Highest Since 2007

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Photographer: Jin Lee/Bloomberg

A pedestrian carries an umbrella while talking on a mobile phone as she passes a Verizon Wireless store in New York.

Credit quality for U.S. companies is showing signs of weakening as issuers from Verizon Communications Inc. (VZ) to Apple Inc. borrow unprecedented amounts of money to expand and reward shareholders.

A total of 223 companies had their bond ratings cut by Moody’s Investors Service in the six months ended November, compared with 172 increases, the highest proportion of downgrades since April. Issuers took advantage of borrowing costs that averaged a record-low 3.83 percent this year to sell an unprecedented amount of bonds, with 15 percent of offerings funding shareholder payouts, the most in five years.

As the U.S. economy enters its fifth year of expansion after the worst recession in seven decades, Moody’s predicts that companies will be emboldened to seek out acquisitions and increase spending to enrich their owners. That may prompt borrowers to boost leverage, which has risen to the highest level since 2007.

“We’re in a mature recovery, and companies may take that as a sign to be more aggressive with their balance sheets,” Ben Garber, an economist at Moody’s Analytics, said by telephone from New York. They may be “investing more, doing more M&A and returning a lot more of their cash to shareholders.”

$1.5 Trillion

Companies in the U.S. sold $1.5 trillion of bonds through Dec. 24, with the highest percentage of proceeds used to fund shareholder-friendly transactions since at least 2008, according to data compiled by Moody’s and Bloomberg. About 4 percent of bond offerings in 2008 were used to reward shareholders, Moody’s data show.

Potential downgrades exceeded those of upgrades by Standard & Poor’s on Nov. 29 by 222 to 188, according to a report by S&P analysts led by Diane Vazza, the New York-based head of global fixed-income research.

The number of U.S. companies with the lowest credit ratings jumped to the highest level in six months after speculative-grade borrowers obtained a record amount of bonds and loans in 2013, according to Moody’s data. There were 156 borrowers rated B3 with a “negative” outlook, up from 148 three months ago and the most since 160 in June, with the rise reflecting the “aggressiveness of the origination,” David Keisman, a senior vice president at New York-based Moody’s, said in a telephone interview last week.

Ratings Cuts

Moody’s has cut 495 long-term ratings and promoted 397 this year in the U.S., according to Bloomberg data that tracks the number of ratings changes on securities. S&P reduced 399 grades and awarded 604 upgrades, the data show

Among companies whose ratings were cut by Moody’s, H.J. Heinz Co. fell six levels to B2 from Baa2 after Warren Buffett’s Berkshire Hathaway Inc. completed a $27.4 billion takeover of the ketchup maker.

The credit rater cut Dell Inc. eight levels after founder Michael Dell led a group of investors to take the personal computer company private in October.

Company leverage, or median debt to earnings before interest, taxes, depreciation and amortization, has climbed to more than 4.2 times through the second quarter, the highest level in at least six years, according to Moody’s data of public and private non-financial North American companies.

‘More Leverage’

Yields on the Bank of America Merrill Lynch U.S. Corporate & High Yield index fell to a record low of 3.35 in May from as high as 11.1 percent in October 2008. The extra yield investors demand to own the securities rather than government debentures reached a more than six-year low of 1.88 percentage points Dec. 23, index data show.

“You’re going to get more leverage on company balance sheets rather than less,” Scott Colyer, chief executive officer of Monument, Colorado-based Advisors Asset Management, which oversees about $11.6 billion. “There’s going to be more demand for borrowing. Rates are still historically very, very low.”

Verizon raised $49 billion of debt on Sept. 11, the biggest corporate bond offering ever, for its $130 billion deal with Vodafone Group Plc to take full control of its Verizon Wireless unit. The new debt almost doubled the New York-based company’s $49.2 billion of borrowings and has raised its ratio of debt to Ebitda about 3 times from 1.6 times.

Apple Inc. (AAPL)’s $17 billion issue in April, the previous record, helped fund a $100 billion capital reward for shareholders. The company saw its leverage increase to 0.3 times from zero.

Profit Growth

Profit growth at U.S. companies has slowed to 5.7 percent year-over-year in the third quarter, below the 9.5 percent average over the last five years, according to Commerce Department data.

“Companies are not using their cash for long-term growth, but rather for shareholder givebacks,” Jody Lurie, a corporate-credit analyst at Janney Montgomery Scott LLC in Philadelphia, said in a telephone interview.

Elsewhere in credit markets, the cost to protect corporate bonds from default in the U.S. fell to a six-year low, headed for the biggest annual decline since 2009.

The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark used to hedge against losses on corporate debt or to speculate on creditworthiness, has dropped 32.4 basis points this year to a mid-price of 62 basis points as of 9:11 a.m. in New York, according to prices compiled by Bloomberg.

That’s the lowest level since Oct. 31, 2007, and the biggest annual decline since the benchmark fell 119.5 basis points in 2009.

General Electric

The index typically falls as investor confidence improves and rises as it deteriorates. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Bonds of General Electric Co. (GE) are the most actively traded U.S. corporate securities by dealers this year, accounting for 3.3 percent of trades of $1 million or more through Dec. 24, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

In emerging markets, relative yields have widened 58 basis points this year to 324 basis points, or 3.24 percentage points, according to JPMorgan Chase & Co.’s EMBI Global index.

To contact the reporter on this story: Matt Robinson in New York at mrobinson55@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

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