Over the past few years, companies issued record volumes of debt, and now that interest rates have doubled in the past six months finance teams are becoming nervous. This is understandable for companies with floating-rate debt or significant upcoming maturities. But otherwise, CFOs can find some comfort knowing that interest expense growth will likely lag the increase in rates. A much more critical issue for borrowers is the seeming decline in the availability of capital.
For the last several years, access to capital has been cheaper and deeper than perhaps any time before. As private debt capital has grown from nearly nothing at the turn of the century to more than a trillion dollars today, borrowers have become accustomed to capital from all types of sources — from banks to business development companies, non-bank lenders to credit funds, pension plans to insurance companies, and specialty lenders to the largest asset managers.
Now, as the Federal Reserve reduces the size of its balance sheet and debt market tides recede, there may be far fewer chairs available when the proverbial music stops. If nothing else, the credit curve could get a lot steeper as investors continue to differentiate bond or credit quality, resulting in dramatic spread decompression.
We are already seeing investors be more discerning. Lenders are fatigued and exiting long-term relationships, forcing borrowers to scramble for new providers. Institutional debt investors have many attractive relative value alternatives and, for the first time in years, are passing on transactions because they don’t have the resources to pursue every deal. Relationships between some companies and investors are straining under the pressure.
The good news is that the markets remain mostly open, and rates are still relatively low — although that may not be the case for long. Firms need to prepare for the potential storm. Here are five initiatives for the proactive CFO to consider:
- Strengthen core operating credit performance and corporate credit rating. Take steps to increase cash flow and reduce debt, improve earnings visibility, and mitigate credit agency concerns to improve the organization's credit profile.
- Refinance near-term debt maturities (even at these higher rates). Extend debt maturity towers and create financing runway by tendering, exchanging, and refinancing debt to offset the impact of declining liquidity.
- Maximize and extend bank revolvers and credit facilities. Reinvigorate bank and lender relationships with a focus on credit strength, transparency, and continued development of mutual business interests.
- Reduce covenant restrictions and create more financial flexibility. Review financial agreements to remove legacy limitations, reduce reporting and compliance triggers, and increase degrees of financial freedom.
- Develop alternative sources of capital from asset finance to junior capital. Consider alternative applicable financing strategies, such as private debt and equity, to diversify capital resources and expand competitive dynamics.
At the current pace, we expect credit conditions will intensify in the near term. So, most borrowers should stop worrying that interest rates are rising and focus instead on maximizing access to capital. Start acting now, before it’s too late.