Gross Leverage Shifts into High Gear

April 6, 2017

Gross Leverage Shifts into High Gear Photo

Over the last several years, there has been a rather large shift in the amount of gross leverage corporate credits have been willing to endure. Today’s chart shows over 50% of investment-grade corporate debt in the JPMorgan non-financial universe had gross leverage under two times EBITDA* at the end of 2012. By the end of 2016, this fell substantially to 20% of the universe. At the other end of the spectrum, this period saw debt levered over four times EBITDA go from 11% to 25%.

The prolonged low global interest rate environment and challenging growth backdrop has spurred debt-financed mergers and acquisitions and shareholder-friendly activities, leading to this shift in leverage. Also contributing to the swing has been the material decline in oil and other commodity prices, which has caused EBITDA to decline and leverage to rise in the energy and metal & mining sectors.

Despite the rise, average quality has only declined by one notch to the A3/Baa1 range as rated by Moody’s in the Barclays Corporate Credit Index as the increase on a net basis has been more modest. The rating agencies have been somewhat accommodative to meaningful gross leverage increases as long as the credits demonstrate a well-defined path to pay down debt over a reasonable time period. The credit markets have also taken a relatively patient view of the rise in gross leverage. The index option adjusted spread has tightened over the last four years from 141 basis points (bps) to 123 bps. However, spreads are off the tights of 97 bps experienced in 2014 when crude was near $90/barrel and the interest rate environment was essentially the same as it exists  today.

Key Takeaway:

The gross leverage picture has shifted notably higher for investment grade non-financial debt over the past several years during a time when spreads have also tightened. Although net leverage has not experienced a shift of this magnitude, corporate credit spreads leave little room for companies to misfire on their deleveraging plans and creates a challenging market environment for corporate credit investors.

*Earnings before Interest, Taxes, Depreciation and Amortization

Tags: Chart of the Week | Energy | Credit spreads | Metals & Mining | Investment grade debt | Corporate credit | Gross leverage

< Go to Chart of the Week

The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.

This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.  This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.

Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice.  The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete.  Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements.  Actual results may differ significantly.  Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.

Investing involves risk, including possible loss of principal.  Past performance is no guarantee of future results.  All information referenced in preparation of this material has been obtained from sources believed to be reliable, but accuracy and completeness are not guaranteed. There is no representation or warranty as to the accuracy of the information and Penn Mutual Asset Management shall have no liability for decisions based upon such information.

High-Yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Investing in higher yielding, lower rated corporate bonds have a greater risk of price fluctuations and loss of principal and income than U.S. Treasury bonds and bills. Government securities offer a higher degree of safety and are guaranteed as to the timely payment of principal and interest if held to maturity.

All trademarks are the property of their respective owners. This material may not be reproduced in whole or in part in any form, or referred to in any other publication, without express written permission.

Subscribe to Our Publications