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Everybody BBB

08 March 2019

 Salomons Judgement

A trend becomes visible. Suddenly there are large companies wanting to protect their credit status. The bond holder has priority over the shareholder.

Last week, a journalist called me with some interesting questions about balance management. On the one hand we still see a lot of corporate-bond issuances, but now there are also companies moving in the other direction. What’s going on? Nice question. With – unfortunately for the journalist – a nuanced answer.

There are two stories. One is that there are companies with good profitability and a solid balance sheet that must realize profit growth. As there isn’t much economic growth at the moment, the earnings per share may be increased through debt-financed acquisitions. Or by slightly expanding the balance sheet and buying some shares. The extra costs of a somewhat lower credit status are marginal.

Borrow some extra money? The shareholders welcome it and the bond holders don’t stand in the way of it. Use the low interest rates as long as possible! What is the lowest spectrum of investment grade? BBB? Then let’s do that! More than 50% of the companies now have that rating. After the financial crisis, only a third of the companies was rated BBB.

Lower than BBB

The second story is that of companies with a rating already slightly lower than BBB, or with a credit assessment that is under pressure. As long as the interest burden is low, the junk status is not necessarily a problem. At the end of last year, however, we experienced the risks. A small setback in growth, a slightly too aggressive policy by the central bank and the liquidity on the bond market disappears in a second. 

In December 2018 there was not one single issuance of high-yield bonds. That is an undesirable situation, especially for the big players. A trend becomes visible. After General Electric and Anheuser-Busch InBev, ketchup king Kraft Heinz also opted to put the interests of bond holders before shareholders. The company cuts off  the dividend and uses the turnover of assets to reduce the debt. The investment-grade credit rating must be protected.

Everyone wants to be BBB. It is a clear signal that we are at the end of the credit cycle. The healthy companies still want to benefit from the good times. The less healthy companies try to put the balance sheet in order before things go wrong. And investors have to separate the wheat from the chaff because of the considerable risks at individual company level. Finally.

The author

Roelof Salomons

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