Reliance on cheap cash has been the regular modus operandi for corporate America for years, but with $4 trillion in debt maturing over the next five years, it is about to get tested.
New Borrowing Environment
It is clear that as the Federal Reserve looks to tighten its policy with higher interest rates, U.S. companies that have focused on tapping global markets for inexpensive finance during the last four years will find themselves in a very different environment.
Aware that this moment is coming U.S. corporate treasurers have hurried to take advantage of cheap borrowing costs before the borrowing rates rise, managing to refinance over $1trillion each year between 2012 and 2014.
For years companies have had easy access to a lot of cheap cash, allowing to fund multibillion-dollar takeovers, fund buybacks and dividend strategies. This activated has been embraced by investors who have watched share prices rally after the 2009 lows. However, new borrowing circumstances may mark a turning point in this debt spree.
Increase in Defaults
As traders and economist are betting whether Fed will lift interest rates in December or even as early as this month, investors may be hit with the other side of cheap financing. Many analysts agree that more companies will begin defaulting than before, especially in energy sector which is particularly vulnerable due to falling commodity prices.
Both Moody’s and S&P are cautioning that defaults will most likely increase in the following years as borrowing rates rise, sentiment echoed by bond funds such as Pimco. S&P analysts expect defaults amid junk-rated U.S. companies to hit a worrying 2.9 percent by June next year, nearly doubling the rate of 2013, while Moody’s list of companies which are rated B3 with a negative outlook or lower has passed 200 for the first time in five years.
The prospect is worrying for many, considering that the increase in corporate debt has led to the deterioration in many U.S. corporations health, as the debt burden of high grade companies has reached its highest level since 2002. For many of these companies, knowing a problem is looming and being able to do anything about it are often two very different things.