U.S. corporations bolstered their financial positions in the second quarter, reducing their reliance on debt and the burden of interest payments.
Companies are burning through cash reserves they built during the pandemic era of cheap money to pay down debt as sticky inflation raises the prospect of repeated interest rate hikes and an increasingly expensive borrowing environment.
The median debt-to-equity ratio — calculated as total liabilities as a percentage of shareholder equity — for nonfinancial U.S. companies rated investment-grade by S&P Global Ratings fell to 88.6% in the second quarter from 90.1%. The median ratio for non-investment-grade companies is also down, from 125.4% to 123.4%, according to the latest data from S&P Global Market Intelligence.
Paying down debt
The debt ratio has consistently fallen in recent years as companies unwind the debt built up in early 2020. Faced with an economic collapse as COVID-19 swept across the world, companies piled on debt to bolster cash reserves.
Companies are now reducing those cash stockpiles, preferring to pay down debt rather than refinance at higher borrowing costs. Debt ratios are now significantly lower than the pre-pandemic level.
The declining debt burden is contributing to rising interest coverage ratios as the interest expense on outstanding debt declines relative to earnings.
Strong earnings boost finances
The median interest coverage ratio for nonfinancial investment-grade companies rose to 9.1 in the second quarter of 2022, up from 8.4 in the first quarter. For non-investment-grade companies, the increase was to 4.5 from 4.0.
The interest coverage ratios benefited from another strong earnings season as companies defied high inflation and the Federal Reserve started to raise rates. But with persistent inflation forcing the Fed to raise rates further, the outlook for earnings is weaker.
Investment-grade utilities are the only sector with a lower median interest coverage ratio than before COVID-19 reached the U.S., but these companies typically have the lowest ratio of all the sectors, in part due to the reliability of customers paying their energy bills.