Will Corporate Credits Crack as Growth Slows?
This Time Is Different (Really)
First, we don’t expect a recession. We think central banks can thread the needle to curb inflation without tipping their economies into a nosedive. Second, even in the event of a recession, we expect the corporate sector to hold up well.
Typically, a sharp slowdown or recession is bad news for corporations, which can struggle to secure cheap and adequate funding, given tighter credit conditions and slowing demand. That struggle is largely a function of a company’s creditworthiness at the start of the slowdown—that is, a company that is already overstretched will run into problems very quickly when the spigot dries up.
But today’s corporate bond issuers are in much better shape financially than issuers entering past recessions, thanks in part to an extended period of uncertainty surrounding the coronavirus pandemic. This uncertainty led companies to manage their balance sheets and liquidity conservatively over the past two years, even as sales and earnings recovered.
As a result, leverage and coverage ratios have improved, as have free cash flow and margins, across Europe and the US, and for high-yield and investment-grade credits. To confirm these metrics, we conducted an in-depth historical “constant universe” analysis of the US investment-grade corporate market, adjusting our issuer universe to eliminate survivorship bias, changes in composition and other distortions.
The result is a “constant universe” that shows just how much leverage has declined and coverage ratios have increased over the past 12 months, compared to the precipice of the COVID-19 pandemic in early 2020 (Display).