Second Quarter Corporate Earnings: Mild Credit Deterioration in Non-Financials

SNWAM positioning reflects mild weakening in second-quarter non-financial investment-grade credit metrics. Revenue and earnings-before-interest-tax-depreciation-and-amortization (EBITDA) grew 2% year-over-year, a tepid trend we have seen over the past several quarters. Troublingly, the proportion of EBITDA paid to shareholders via share repurchases and dividends – a negative for bond creditworthiness – increased to 36% for non-financial companies, only 3 percentage points lower than the peak reached in the first quarter of 2008. Leverage – another negative for credit – increased only slightly when excluding the biggest borrowers, Verizon and AT&T. Debt grew 7.6% year-over-year, consistent with growth over previous years, and is now at the highest point ever, nearly $3 trillion in aggregate compared to less than $1 trillion in 2000. Interest expense grew 3.9%, which, along with higher debt levels, caused interest coverage ratios to worsen. In response to these trends, SNWAM positioning remains modestly underweight corporate credit.  Despite unfavorable developments in credit quality, the additional yield investors demand beyond government-backed bonds has continued to narrow. Strong US GDP growth appears to be the driver, but we remain cautious of increasing exposure when fundamental credit quality is waning.