Big American companies have been living in a debt dreamland. Borrowing at cheap rates has boosted profits for decades, with the biggest firms insulated from the Federal Reserve’s recent tightening. Many borrowed heavily at low, fixed rates during the pandemic. Although they will eventually need to refinance at higher rates, for now, the maturity wall of debt looks manageable.
Not all companies are spared from the Fed’s actions, though. Trillions of dollars of floating-rate debt, with interest payments adjusting along with the market, have suddenly become much more expensive. Leveraged loans and private debt market borrowing make up this hefty pile of debt. Companies rarely hedge interest-rate risks, and now find themselves facing steep payments—the yield-to-maturity of one index of leveraged loans has soared to nearly 10%. With resilient American economic growth, Fed policymakers warn of the need for higher interest rates, pushing more borrowers to breaking point.
Since the global financial crisis, American companies have been borrowing with abandon. Traditional leveraged loans, as well as private credit lending, have served the private-equity buy-out boom, growing to a combined value of over $2.9 trillion. Default rates rose to 3% in the leveraged loan market in the past 12 months, up from 1% a year earlier. Fitch projects it could jump to 4.5% by 2024.
Company borrowers are struggling to meet the costs of their floating-rate debt, with interest expenses soaring. Most businesses with unhedged floating-rate debt balances are vulnerable, especially those loaded with debt in high-valued private-equity buy-outs.
Efforts are now being focused on which investors will be hit the hardest. As recovery rates across junk-rated debt lag behind long-run averages, more borrowers depending solely on loans could further depress recoveries. The trend of rising interest rates has concentrated the pain and is likely to leave less value for leveraged-loan investors.
Long-term trends will continue to fuel trouble in the leveraged-loan market, as maintenance covenants have all but disappeared and excessive “add backs” could mean borrowers are in worse shape than the market believes.
Problems in floating-rate debt markets are unlikely to cause a financial crisis, but the murky and growing size of private markets has regulators concerned. Efforts have been made to increase transparency and regulatory bodies are taking note of the risks.
Ultimately, the debt landscape for American companies is changing and the risks are real. While this won’t cause a financial crisis, it does raise concerns and the need for vigilance.
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