Earnings Wins Put $150 Billion of Debt on Trajectory Out of Junk

(Bloomberg) -- Healthy third-quarter earnings are a sign that more companies will win back investment-grade credit ratings, even as the pandemic drags on, BNP Paribas SA predicted.  

Strategists at the French bank forecast as much as $112 billion of debt in the U.S. and 31 billion euros ($36 billion) in Europe will cross the threshold in the coming 12 months. They cited strong earnings growth, leverage ratios at pre-Covid levels, and supportive credit conditions.

“The healthy fundamental backdrop should drive rising stars in the near term,” the strategists led by Viktor Hjort wrote in a note. “Many companies are focused on deleveraging.”

Spotting companies with the potential to escape from junk can be a lucrative trade for investors, particularly at a time when high-grade spreads are near the tightest on record. Such promotions historically mean yields can come in by 30 basis points to 35 basis points when compared with BBB-rated credit, the lowest investment-grade rung.

Read More: Economic Recovery Boosts European Corporate Ratings: S&P Global

Most of that outperformance takes place in the run up to the upgrade, according to BNP Paribas. But spreads can continue to tighten by as much as 10 basis points in the months afterward, as investment-grade portfolios readjust their holdings to stay in line with the benchmark index.

While third-quarter earnings on both sides of the Atlantic have shown resilience, there are signs accelerating inflation will cloud the outlook. Wednesday’s stronger-than-forecast data on U.S. consumer prices dealt a blow to the argument that price pressures are transitory. 

There was also a modest decline in companies’ liquidity ratios over the past quarter, BNP said. At the same time, these remain at levels above the trailing-five-year average for both U.S. and European corporates.

For now, a global economy awash in stimulus softens “all sorts of vulnerabilities,” the strategists wrote. “Corporates have liquidity and central banks will still be growing balance sheets for some time.” 

©2021 Bloomberg L.P.