Rating agencies have forecast gloomy credit conditions and waves of defaults for U.S. businesses, but lenders and borrowers are taking their sweet time getting there.
Chapter 11 bankruptcy filings have soared this year compared with last, and companies feel the sting of higher interest rates, but high-profile cases of business financial distress or delinquencies have been limited.
In The Duke/Richmond Fed CFO Survey released this week, high rates are affecting spending, but access to credit or funding ranked only ninth on the list of most pressing concerns for U.S. finance executives. About 14% of firms that pulled back on capital and other spending cited reduced access to credit or financing. For companies that don’t plan to make any equipment or structure expenditures in the next six months, 24% said financing was “unfavorable.”
"The costs of debt service and/or refinancing could be overly burdensome in this higher-for-longer environment, especially for lower-rated borrowers."
David Tesher,
Head of North America credit research, S&P Global Ratings
A still-strong U.S. economy has helped buoy highly leveraged companies. Still, a Fed funds rate that is higher for longer could finally burst the dam and cause companies with low-rated credit to suffer, according to the credit rating agencies.
“Credit conditions for borrowers in North America look set to [deteriorate slowly], with all-in borrowing costs unlikely to fall any time soon, inflation continuing to erode consumer purchasing power, and investor risk appetite more guarded,” S&P Global Ratings said in a September 26 report.
S&P said the credit stress would build for lower-rated credit (“B-” and below) “particularly in consumer-driven sectors.”
"The costs of debt service and/or refinancing could be overly burdensome in this higher-for-longer environment, especially for lower-rated borrowers," said David Tesher, S&P Global Ratings' head of North America credit research.
Slowing Economy
The help from a resilient economy won’t last, according to S&P. The firm expects a “soft landing,” but thinks the real economy will be “considerably weaker next year” — with GDP growth slightly less than the 1.5% predicted by the FOMC’s “dot plot” projections.
According to a Fitch Ratings report on Thursday, interest coverage ratios, used to show how easily a company can pay interest on its debt, will decline modestly for corporate issuers through 2024.
The cause will be “higher-cost, floating-rate debt and the refinancing of lower-cost, maturing debt at prevailing market interest rates,” said Fitch, combined with “relatively flat EBITDA as risks to the world economy remain.” Earnings growth "is not likely to provide an offset to higher interest payments,” Fitch said.
But so far, many corporate and business borrowers are staying above water. “Investment-grade issuers have mitigated rising debt-service costs by resizing their balance sheets and repurposing their cash,” said S&P.
Speculative-grade issuers have seen defaults, but the largest share of defaults have occurred through distressed debt exchanges, “indicating that many issuers are compelled to restructure their balance sheets when facing upcoming maturities,” said S&P.
Borrowers have also lowered near-term maturities. Speculative-grade corporate maturities due in the second half of 2023 and 2024, were trimmed by 31% and 23%, respectively, this year, said S&P.
“Borrowers and lenders anticipated defaults, which primarily resulted not from declining earnings but from increases in interest rates, and proactively addressed the issue by amending the loan documents."
Lincoln International Q2 Senior Debt Index
Private Market Measures
Borrowers and lenders in the private credit markets have also found ways to stave off doom. According to The Lincoln Senior Debt Index (LSDI) for the second quarter, covenant defaults fell to 4.2% from 4.5% in the first quarter. Almost 15% of all companies that investment bank Lincoln International’s index tracks executed amendments to their debt terms this year.
“Borrowers and lenders anticipated defaults, which primarily resulted not from declining earnings but from increases in interest rates, and proactively addressed the issue by amending the loan documents,” Lincoln said in its index analysis.
Of the 425 amendments, 31% had sponsors injecting equity while 38% had increases in interest spreads (33% of which included some payment-in-kind interest), according to Lincoln.
The hoped-for reversal of the Fed’s tightening cycle — interest rate cuts — may be too late to help borrowers burdened with high-interest costs.
According to a September 25 S&P report, U.S. Economic Outlook Sees Slowdown Delayed, Not Averted, “the last mile of disinflation is going to take longer, with core inflation taking another 12 months to get comfortably near the Fed's 2% target.”
Unless there’s a severe economic downturn or a geopolitical event that drastically weakens business activity before then, rates may be too slow in falling to have a material impact on the cost of credit for companies still facing maturities in 2025 and 2026.
