U.S. companies are well-positioned to handle the increasing cost of debt.
Company balance sheets are healthy as executives took advantage of cheap debt to refinance during the COVID-19 era, leaving them better able to handle rising interest rates and tightening financial conditions.
Debt burden is lower than pre-COVID-19
The median interest coverage ratio — a measure of a company's ability to repay its debts calculated by dividing earnings before interest and taxes by the cost of its debt-interest payments — for nonfinancial U.S. companies rated investment-grade by S&P Global Ratings was 8.1 in the fourth quarter of 2021, according to the latest S&P Global Market Intelligence data.
While this was down from the recent high of 8.6 in the second quarter of 2021, the ratio remains significantly higher than the pre-pandemic level of 6.1, according to data published by S&P Global Market Intelligence.
The economic shock of COVID-19 was short-lived as the Federal Reserve slashed rates and pushed bond yields down with quantitative easing. Stimulus checks issued by the U.S. government bolstered household incomes and supported a sharp — and inflationary — rebound in consumer spending, which boosted corporate revenues.
The financial health of lower-rated companies continues to improve to new highs. The median ratio for non-investment-grade-rated companies rose to 4.1 in the fourth quarter of 2021 from 3.7 in the third quarter, the seventh consecutive quarterly rise. The pre-COVID-19 level was 2.8.
Tougher outlook
The improvement in balance sheets is well-timed as borrowing costs rise.
The yield on the S&P U.S. Investment Grade Corporate Bond Index rose to 3.96% as of April 19 from 2.2% at the end of 2021, indicating the higher rate of interest a company would have to pay to borrow in the bond market.
Credit spreads have also widened, suggesting investors are increasingly risk-averse and cycling out of corporate bonds at a faster rate than Treasurys. If spreads were to widen further, this could indicate liquidity in the bond markets is drying up, making it harder for companies to borrow and roll over debt.
That is more of a problem for companies with low-interest coverage ratios such as utilities, real estate and communication services, rather than sectors with lower debt repayment burdens such as consumer discretionary, information technology and materials.
