Low levels of maturing debt in the near term mean that companies with non-investment grade credit ratings should be largely protected from the consequences of sharply rising borrowing costs.
The Federal Reserve raised rates by 75 basis points on June 15, the sharpest rate hike since 1994, as the central bank seeks to reverse runaway inflation. This would normally be bad news for highly indebted companies that need to issue bonds or take out loans to refinance old debt or make investments. Yet declining volumes of bond issuance suggest that many companies are in no rush to tap markets, having pushed out their "maturity wall" — the point at which debts have to be repaid or refinanced — through record levels of bond issuance in 2020 and 2021.
"Rising rates will present challenges but companies with more longer-term, fixed-rate debt already have a buffer in place that can provide them with some time to adjust to higher funding costs," said Evan Gunter, director of Ratings Performance Analytics at S&P Global Ratings.
Just 5% of the 1,554 North American issuers rated BB+ or lower (non-investment grade) have debt maturing in the second half of 2022, according to Ratings. That grows slightly to 16% by the end of 2023 and 33% through 2024.
The amount of non-investment-grade-rated debt scheduled to mature in the second half of 2022 is $56.1 billion. In 2023 the total is $172.3 billion and grows to $306.4 billion in 2024. Ratings forecasts that speculative-grade maturities in the U.S. will peak in 2028.
That is a "manageable" level, according to Ratings. Some $464.5 billion of non-investment grade bonds were issued in 2021, suggesting that if investor demand for corporate bonds persists, companies should not find it too difficult to find buyers of their debt.
Healthy balance sheets can survive rising rates
The cost of borrowing is rising. The yield on the S&P U.S. High Yield Corporate Bond Index yield has climbed to 8.56% as of July 1, up from 4.22% at the start of the year, as investors price in rising interest rates and a slowing economy.
The amount of corporate debt considered "distressed" by Ratings more than doubled in May to $49.2 billion from $25.8 billion in April as a result.
Yet corporate balance sheets remain healthy on the whole in both the higher quality and lower quality segments.
"On aggregate, leverage remains elevated but has been relatively stable over the last couple of years," said Julien Lafargue, chief market strategist at Barclays Private Bank. "More importantly, the [interest] coverage ratio remains strong, pointing to limited risks as long as the U.S. economy does not fall into a severe recession."
Both investment grade and non-investment-grade-rated companies built up their cash positions early on during the pandemic by taking advantage of low interest rates and ample liquidity in credit markets provided by the Federal Reserve's multi-trillion dollar quantitative easing program.
"It is evident that corporates appear to have done the heavy lifting over the past couple of years, strengthening their balance sheets, extending their maturity profiles and building up their liquidity," Chris Holman, managing partner at TwentyFour asset management, said in a research note. "With limited refinancing risk currently in the market, we think this will continue to be a supportive facet to why default rates should remain below the historical average."
The strong balance sheets have encouraged companies to keep spending. Expenditures on share buybacks broke the quarterly record in the first three months of 2022. The total of $281 billion between January and March was 4% higher than the fourth quarter of 2021 total — the previous record level.
While buybacks are dominated by the world's largest companies — Apple Inc. was the biggest actor in the space, buying back $22.96 billion of its own shares — the indicator highlights the strength of corporate balance sheets and the plethora of cash available.
The 12-month-trailing speculative-grade default rate of the U.S. was just 1.4% in March, according to Ratings. This historically low level is not expected to persist as profit margins are squeezed, economic growth slows and monetary tightening raises costs.
"Companies already face rising funding costs on the floating-rate portion of their debt structure, and more will face rising costs as they refinance fixed-rate debt that was issued in periods with lower interest rates," Gunter said.
Yet the rate of default will still only be at about 3% by March 2023, according to Ratings, indicating that 57 companies will default in the preceding 12 months. This would still be a lower rate than the pre-COVID-19 level of 3.2%.