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July 26, 2018

When the Cycle Turns

As the current credit cycle approaches record length, our "When The Cycle Turns" series looks at the impact that a downturn involving deteriorating economic and credit fundamentals--with rising defaults and scarce liquidity--may have on ratings and market conditions.

When The Cycle Turns: U.S. 'BBB' Corporate Profiles Remain Firm Despite Rising Debt


As total adjusted balance-sheet debt for U.S. nonfinancial corporates in the 'BBB' category has swelled to $2.66 trillion at the end of last year, investors are increasingly wondering what will happen after the next turn in the credit cycle. Specifically, investors are worried about the market fallout that could arise if a sizable number of 'BBB' issuers were to fall from investment grade to speculative grade. Such a scenario could result in a combination of higher capital costs across the rating spectrum because of forced selling by funds or institutions that can only hold higher-rated debt.


When The Cycle Turns: Will Consumer Companies' M&A-Related Debt Result In An Exodus From Investment Grade?


For the past several years, consumer products companies (CPG) have gorged on mergers and acquisitions (M&A) as a way to counter anemic revenue growth--mainly among packaged food companies--that has fallen shy of economic growth. Moreover, as consumers' tastes and preferences shift toward brands that they perceive to be healthier, natural, or more socially responsible, large CPGs are reacting accordingly. For many, that means buying smaller rivals that provide these increasingly popular products and brands.


But that's not the only reason for this increase in M&A. New competition from the rapid growth of digital marketing and e-commerce, which has reduced the barriers to entry for start-up brands, is also making these companies--even industry giants--look for new areas of growth and efficiencies of scale. And for many CPGs, that means gobbling up others in the industry. During the past couple of years, we have seen an uptick in large, transformative transactions. Because of this desire for growth and still relatively low interest rates, the acquirers are paying higher purchase prices for attractive companies.