U.S. Blue Chips Are Healthier Than Leverage Implies

U.S. companies are finding it cheaper to borrow from the investment-grade market, buoyed by a wave of ratings upgrades, faster earnings growth, and improving profit margins, according to Bank of America Corp.

These indicators imply a much better fundamental picture for big corporations than leverage, bank strategists including Yuri Seliger wrote in a note on Friday. While different measures of leverage are rising—with first quarter gross leverage hitting the highest since the second quarter of 2021—the strategists caution against only looking at the backward-looking accounting metric.

On the other hand, risk premiums—the added premium over U.S. Treasuries that companies pay to borrow from the market—have been tightening and are approaching levels last seen in 2021, according to Bloomberg index data.

“It’s not unusual for investment-grade spreads to tighten as market leverage is rising,” the strategists wrote. “Leverage is the key credit fundamental metric, but for investment-grade, other factors often drive spreads instead.”

Leverage increased during each of the three prior periods when high-grade spreads narrowed since 2010, excluding Covid, according to the note.

Among metrics that indicate improvement is the debt-to-enterprise value, which reflects the forward-looking market value of a company. The net debt–to–enterprise value ratio for industrial issuers declined to 0.15, from the recent peak of 0.18 in the third quarter of 2022, according to Bank of America.

Credit ratings for high-grade companies are also improving. Net upgrades totaled $129 billion over the past 12 months, helping keep the average index rating for industrials relatively stable despite a net inflow of rising stars into the high-grade universe. Meanwhile, the median year-over-year EBITDA (earnings before interest, taxes, depreciation, and amortization) growth accelerated to 2.9 percent, from 1.4 percent in the fourth quarter, and revenue growth remained stable.

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