Interest rate rise: turning point looms for US debt binge
With a $4tn mountain of debt maturing over the next five years, corporate America’s reliance on cheap cash is about to get tested.
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.
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.
“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.”
“There’s reason to believe that primary markets on the debt side become less robust once the Fed starts hiking rates, both in terms of the size of deals that can reasonably be priced in markets and also the kind of interest rates companies will have to pay on that debt,” Mr Mikkelsen says.
But not all companies will be affected equally, with indebted energy companies likely to be the biggest victims. Eric Gross, a strategist with Barclays, points out that the concern for lowly rated energy companies is not if they pay 7 per cent or 9 per cent interest rates, but whether “they can get financing at all”.
For the vast majority of solid investment grade companies, the ability to tap debt markets as rates rise has not come into question. Investors have instead wondered what the impact will be on buyback and dividend policies, as well as what obstacles mergers and acquisitions activity will face — important bulwarks for frothy US stock market valuations in recent years.
Marc Zenner, a senior JPMorgan banker, says that higher rates should not be an issue for most companies, particularly if the US economy is improving and sales are healthy. “If rates rise because the economy is doing well and firms are bullish, you could see more buybacks because they’ll be generating more cash flow,” he predicts.
Analysts say the pharmaceuticals and healthcare industry, which has been engaged in a wave of debt-fuelled dealmaking, could be one of the hardest hit sectors when rates rise.
Fitch downgraded its outlook on the sector from stable to negative at the start of the year, though it did little to dampen investor appetite for chunky debt offerings.
Monica Erickson, a portfolio manager with DoubleLine, a bond fund management group, argues that increasing interest rates could spark more responsible behaviour from corporate treasurers that have grown comfortable with cheap and abundant funding.
“It may be better off if rates are rising and companies behave a little better,” Ms Erickson said. “Maybe share buybacks and dividends will decrease, maybe M&A will decrease and perhaps we’ll see less debt issuance.”
Additional reporting by David Crow.