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 in the first five months of the year after reaching a post-crisis high of 1.55 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 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.
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"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, U.S. asset-backed bonds linked to auto debt are poised for the worst month in more than two years. Yields on Fannie Mae and Freddie Mac mortgage bonds that guide U.S. home-loan rates headed for the first decline in six days after reaching the highest since August 2011. The cost of protecting corporate bonds from default in the U.S. fell for a second day.
A Bloomberg index of Fannie Mae's current-coupon 30-year securities declined 0.04 percentage point to 3.48 percent as of 12:10 p.m. in New York. The measure ended yesterday at 3.52 percent and is up from 2.98 percent on June 18. The average cost of new 30-year, fixed-rate home loans has climbed to 4.58 percent from a record low 3.36 percent in December, according to Bankrate.com data.
The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark used to hedge against losses or to speculate on creditworthiness, decreased 3.6 basis points to a mid-price of 88.7 basis points, according to prices compiled by Bloomberg. The benchmark ended June 24 at the highest level since December.
Europe Benchmark
In London, the Markit iTraxx Europe Index, tied to 125 companies with investment-grade ratings, dropped 8.5 to 119.3.
The U.S. two-year interest-rate swap spread, a measure of debt market stress, declined 2.9 basis points to 14.75 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.
Bonds of Chevron Corp. are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 3.04 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.
Top-ranked securities tied to vehicle loans have lost 0.15 percent this month, the largest decline since the securities fell 0.2 percent in November 2010, according to a Bank of America Merrill Lynch index.
Downgrades, Upgrades
Investors are pulling back from auto debt, the largest part of the asset-backed market, threatening to constrain financing to borrowers with blemished credit histories. Subprime vehicle debt accounted for 13.2 percent of asset-backed issuance this year, compared with 10.5 percent in 2012, Wells Fargo & Co. analysts led by John McElravey said in a June 7 report.
Downgrades exceeded upgrades at Moody's Investors Service 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.
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."
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