Central bank efforts to make risky assets more attractive to investors are weakening credit quality among top-rated U.S. companies as they sell debt to return money to shareholders instead of spending on growth, according to Moody’s Investors Service.
Companies with investment-grade credit ratings are spending more of their cash on shareholder rewards than at any time since the 2007, Moody’s said in a report released March 27. Reluctant to commit funds to capital expenditures in a low-growth environment, companies have opted to pay for these buybacks and dividends by issuing new debt amid record-low interest rates, while a drop in free cash flow since before the financial crisis has diminished their capacity to repay these obligations.
“The things that are driving this trend are the policy makers trying to increase the flow of credit with a combination of lower interest rates and QE,” Bill Wolfe, senior vice president at Moody’s, said in a telephone interview, referring to central banks’ quantitative easing programs.
U.S. companies allocated 12 percent of their earnings before interest, tax, depreciation and amortization to dividends in the third quarter of 2014, up from 9.4 percent in 2013, according to Moody’s. The allocation has increased every year since 2007, when it was 4.5 percent.
At the same time, leverage has risen and the proportion of Ebitda converted to free cash flow fell to 20 percent in the third quarter of 2014, compared with 35 percent in 2009. The report was based on analysis of 400 investment-grade U.S. companies.
Wolfe said investors who buy new bonds are inadvertently allowing companies to increase leverage and rewarding them for allocating a greater proportion of their earnings to shareholders returns.
“The debt investor just has fewer alternatives. Where are you going to turn? I don’t think these fund managers can take their money and stay out of the market,” he said.
The situation is unlikely to get much better even as the U.S. Federal Reserve prepares to raise interest rates this year and the world’s biggest economy continues its recovery, he said, as the European Central Bank pursues its own measures to stimulate economic growth in that region.
“It’s when low rates and QE start to fade that you will see this behavior start to fade,” Wolfe said.
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