The prediction was simple and clear. The rapid rise in interest rates orchestrated by the Federal Reserve would limit consumer spending and corporate profits, drastically reduce employment, and cool a red-hot economy.
But things didn’t go as forecasters expected. Inflation has eased, but the nation’s largest companies are avoiding damage from higher interest rates. Businesses continue to hire as profits pick up again, giving the economy and stock market more momentum than most expected nearly two years ago when the Federal Reserve began raising interest rates.
There are two main reasons why large companies have been able to avoid the hammer of rising interest rates. The average interest rate on existing household mortgages remains just 3.6%, reflecting the millions of owners who bought or refinanced their homes on the lower-cost terms that were prevalent until early last year. American corporate leaders are locking up cheap capital at home. The bond market before interest rates started rising.
And as the Fed raised interest rates from near zero in early 2022 to more than 5%, these companies’ chief financial officers began directing excess cash to investments that generate higher levels of interest income.
This combination caused U.S. companies’ net interest payments (debt debt minus income from interest-bearing investments) to plummet to $136.8 billion by the end of September. According to the data, this was a low he had not seen since the 1980s. Bureau of Economic Analysis showed that.
That may change soon.
Many small and medium-sized enterprises and some high-risk corporate borrowers are already experiencing higher interest costs, but unless interest rates begin to fall, large companies face sharp increases in borrowing costs in the coming years. will do. That’s because the next two years will likely see a wave of debt in the corporate bond and loan markets, forcing companies to refinance their debt at higher interest rates.
The junk bond market is facing a “refinancing wall.”
About a third of the $1.3 trillion in debt issued by companies in the so-called junk bond market, where the riskiest borrowers finance their businesses, will be paid off within the next three years, according to a Bank of America study. The deadline is reached.
The average “coupon” or interest rate on the bonds sold by these borrowers is approximately 6%. But borrowing now costs companies nearly 9% more, according to an index run by ICE Data Services.
Credit analysts and investors acknowledge it is unclear whether the ultimate damage will be manageable or sufficient to worsen the economic downturn. The severity of the impact will largely depend on how long interest rates remain high.
“I think the question people are really concerned about is, is this going to be the straw that breaks the camel’s back?” said Jim Caron, a portfolio manager at Morgan Stanley. “Will this cause a collapse?”
The good news is that in the junk bond market, only about 8% of outstanding bonds are due by the end of 2024, according to data compiled by Bloomberg. Essentially, less than a tenth of the collective debt pile is in urgent need of refinancing. However, borrowers may feel the higher cost of borrowing sooner. Companies with junk ratings typically try to refinance early to avoid relying on last-minute investors for financing. In any case, the longer interest rates remain high, the more companies will have to absorb higher interest costs.
Some of the companies most exposed to higher interest rates include “zombies,” or companies that are already unable to generate enough revenue to cover their interest payments.These companies were able to stay afloat when interest rates were low, but could be forced into bankruptcy when interest rates rise..
Atsi Sheth, managing director of credit strategy at Moody’s, said even if the challenges are managed, they could have a measurable impact on growth and employment.
“If we can say that the cost of borrowing to do these things is a little bit higher now than it was two years ago, that could lead to more business leaders making decisions like this,” Sheth said. Stated. Maybe I won’t set up that factory. We’ll probably cut production by 10 percent. We might close down the factory. You might get people fired. ”
Small and medium-sized enterprises face various problems.
Some of this potential impact is already evident elsewhere, including in the vast majority of companies that do not raise money through the conspiracy of selling bonds and loans to investors in the corporate bond market. These companies, small private businesses that account for about half of the country’s private sector jobs, are already having to pay even more debt.
They use cash from sales, business credit cards, and personal loans to finance their operations. These are all typically more expensive options for payroll and business financing. A few years ago, small businesses with good credit ratings paid 4% on bank lines of credit, according to the National Federation of Independent Business, an industry group. Currently, they pay 10 percent interest on short-term loans.
Even as spending slows at these companies, hiring is slowing and credit card balances are higher than they were before the pandemic.
“This suggests that more small businesses are using credit cards as a source of funding rather than paying their balances in full,” Bank of America analysts said. “It shows the financial stress on some companies,” he added. It’s not yet a widespread problem.
Corporate acquisitions are also being experimented with.
In addition to small and medium-sized enterprises, some vulnerable private companies with access to corporate credit markets are already suffering from rising interest rates. Backed by private equity investors (who typically take on debt to acquire companies and extract financial profits), these companies borrow in the leveraged loan market, where borrowings include Typically, floating interest rates are applied that move up and down in line with Federal Reserve policy. adjustment.
Moody’s maintains a list of companies rated B3 negative or lower, a very low credit rating given to companies in financial distress. Almost 80% of the companies on this list are leveraged buyouts backed by private equity.
Some of these borrowers are finding creative ways to extend debt terms or avoid paying interest until economic conditions improve.
Carvana, a used car retailer backed by private equity giant Apollo Global Management, is renegotiating its debt this year to do just that, without including accruing interest that management is deferring. It made it possible to reduce losses in the third quarter.
Managers of at-risk companies believe that with strong overall economic growth and significantly lower inflation, Fed officials may end the rate hike cycle or even cut rates slightly. People are probably looking forward to some positive economic news, such as being able to travel to other countries, on the horizon.
Recent research offers some glimmers of hope.
In September, staff economists at the Federal Reserve Bank of Chicago Announcing model predictions This suggests that, absent a major economic contraction, “inflation will return to near the Fed’s target by mid-2024.” If that happens, lower interest rates could help companies in need of new capital much sooner than previously expected.
At this point, few, including Moody’s Ms. Sheth, consider this a guarantee.
“Companies had a lot on their plate that could max them out next year,” she said.
emily fritter Contributed to the report.