In the last part of this series, we saw how ratings upgrades increased relative to downgrades once the economy started on the path to recovery. Improvement in the up/down ratio commenced one quarter prior to the formal demarcation of the end of the recession. According to the National Bureau of Economic Research, the trough or the lowest point of the recession, was reached on June 30, 2009, and the economy started growing from Q3 2009.
In order to help the economy recover, the U.S. Federal Reserve has followed an accommodative monetary policy since 2008. This has included keeping the Fed funds rate between 0% and 0.25% and monthly bond purchases of longer-term Treasuries (TLT) and agency-backed securities (MBB), with the intention of keeping interest rates low, to spur growth in investments and GDP, creating jobs as well as helping Fed achieve its long-term inflation goal of 2%. However, the excess liquidity in the market may have had some unintended consequences.
Companies have taken advantage of low interest rates to refinance costlier debt, fund mergers and acquisitions, and increase returns for shareholders by increasing dividends and share-buybacks. The S& P 100 Buyback Index, which monitors 100 stocks with the highest buyback ratios, increased 45% in 2013, shadowing the performance of the S&P 500 Index (SPY), which increased by 28%.
Lower interest rates have led to record corporate bond issuances and fund flows in fixed income ETFs (BND). High grade issuance (LQD) in the primary market came in at over $1 trillion in 2013, up from about $515 billion in 2009. Total corporate debt issued in 2013 reached about $1.4 trillion, a new record. Among the corporate issuers queuing for the fund rush was Verizon Communications Inc. (VZ), which sold the largest corporate bond issue on record: the company sold $49 billion in senior notes in September 2013, in order to finance its buyout of Vodafone’s stake in Verizon Wireless, breaking the previous record for the largest issue, which was held by Apple (AAPL) when it issued $17 billion in senior notes in April 2013.
Credit ratings agencies have responded by downgrading those corporates, which appear to be taking on excess leverage. On June 19, 2013, Moody’s downgraded the credit rating of HJ Heinz after the high-leverage LBO transaction by an investor group, including Berkshire Hathaway (BRK-B), was approved, increasing the company’s debt levels dramatically. The downgrade affected about $17.1 billion of rated debt.
Read on to Part 5 of this series to learn more about the impact of economic growth on the credit health of corporates.