Interest rate rise: turning point looms for US debt binge
Eric Platt in New York
With a $4tn mountain of debt maturing over the next five years, corporate America’s reliance on cheap cash is about to get tested.
With the prospect of steadily higher interest rates in the coming years as the Federal Reserve gradually tightens policy, US companies that tapped global markets for inexpensive finance over the past four years will soon face a different environment.
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IN GLOBAL ECONOMY
US corporate treasurers have rushed to lock in cheap borrowing costs in advance of the expected rate rise, refinancing more than $1tn each year between 2012 and 2014, according to Standard & Poor’s.
Tighter borrowing conditions will mark a turning point in the recent debt binge. Companies have had easy access to cash to write cheques for multibillion-dollar takeovers, to fund buybacks and dividend strategies — all welcomed by investors as share prices rallied off 2009 lows.
But as rates turn higher, investors may see the flip side of cheap financing. Analysts warn companies will begin defaulting in greater numbers, particularly in the energy sector, which has found itself in the line of fire as commodity prices languish.
In the first half of 2015, the pace of capital raisings accelerated, with bond issuance from blue-chip companies — those rated “investment grade” by one of the leading credit agencies, such as Apple, Comcast, Exxon and Boeing — jumping nearly 50 per cent from a year earlier. Bond issuance by non-investment grade companies, often called “junk”, is up 21 per cent in the first six months of the year from the same point in 2014.
But this hearty bond borrowing binge could be challenged this year. Traders are betting that the Fed will lift interest rates in December, while many economists and analysts are leaning towards a hike as early as this month. “It has become clear we are close to the point when the Fed starts to raise rates,” says Hans Mikkelsen, a strategist with Bank of America Merrill Lynch.
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That prospect worries some analysts. The increase in corporate debt — often spurred by cheap financing to fund acquisitions or shareholder-friendly measures such as stock buybacks and dividend increases — has led to a deterioration in the health of US companies. The debt burden of US high grade companies has now climbed to 2.62 times trailing 12 month earnings — the highest level since 2002, according to BofA.
Even when excluding sectors rattled by the fall in commodity prices, and adjusting for climbing cash levels, leverage has touched the highest point since 2008 when the financial crisis roiled markets.
Moody’s and S&P warn that defaults are likely to increase in the coming years as interest rates rise, a concern echoed by bond funds such as Pimco. Analysts with S&P expect defaults among junk-rated US companies to hit 2.9 per cent by June 2016, nearly twice the rate in 2013. Moody’s list of companies rated B3 with a negative outlook or lower — its lowest rating rungs in the “speculative” space — eclipsed 200 for the first time since 2010 in July
“Credit quality has been deteriorating by and large over the last three years,” says Bill Wolfe, an analyst at Moody’s. “Speculative grade companies, they’ve taken advantage of very buoyant market conditions over the last few years. The number of weakly rated companies we rate is much greater than it used to be.”
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