Moody's: North American corporate credit quality worsens as companies pay out to shareholders

US investment-grade non-financial corporate credit quality will deteriorate this year as companies continue to limit capital investment while taking on higher leverage and using cash to reward shareholders. Companies are increasing cash dividends, leaving less free cash flow to repay debt today than before the recession, according to a new report from Moody's Investors Service.

In "Macroeconomics and Corporate Policies Eroding Credit Quality in 2015" Moody's notes that even as corporate credit quality deteriorates and returns decline, debt investors continue to invest, creating demand pull and inadvertently rewarding companies that allocate EBITDA in ways that weaken their credit quality.

"Prolonged low interest rates have made dividends more important to investors, leaving companies increasingly fixated on dividend growth," says Moody's Senior Vice President, Bill Wolfe. "But this weakens their credit quality, especially as leverage is rising."

Leverage is increasing while the proportion of EBITDA used to cover interest expenses has remained steady, suggesting that companies are managing to an interest coverage metric rather than leverage and principal to be repaid.

Investors and companies are taking their cues from elevated macroeconomic uncertainty, slow and uneven global economic growth and expansionary money policies, including low interest rates and quantitative easing.

"Low interest rates, ample systemic liquidity and bonus depreciation measures mean companies have more cash, but this has been diverted to benefit shareholders instead of investment," Wolfe says. "Expansionary monetary policies have stimulated credit supply and demand, but capital spending and business investment have not recovered to pre-recession levels, which may portend low future growth."

While the objective of buying back shares is similar to that of paying dividends, Moody's found that share buyback activity relates to company-specific attributes and is not affected by expansionary monetary policies. "Only about 40% of the companies we looked at routinely buy back shares, and these companies have a common set of attributes," says Wolfe.