May 17, 2022 - Economy

How higher borrowing costs hit corporate America

Data: Leveraged Commentary & Data; Chart: Erin Davis/Axios Visuals
Data: Leveraged Commentary & Data; Chart: Erin Davis/Axios Visuals

It’s been five months since the Federal Reserve started hinting it was about to raise interest rates, and two since its first hike — so it's a good time to check in on how the shift in monetary policy is changing corporate America’s borrowing habits.

Why it matters: The Fed is on a mission to make money more expensive — and that's supposed to constrain borrowing and slow the economy.

How it's going: Well, large companies with strong finances — i.e. piles of cash and manageable debt loads — basically haven’t skipped a beat. These "high grade" companies borrowed nearly as much so far this year as they did over the same period last year — and that was a record.

  • Even though borrowing money in the high grade bond market now costs about 2 percentage points more than it did late last year, big companies with good balance sheets can absorb that extra cost fairly easily, says Chris Forshner, head of high grade finance at BNP Paribas.
  • As a result, high grade companies haven't really slowed down when it comes to refinancing — or to M&A, much of which gets funded with debt. (For example, Discovery bought WarnerMedia with the help of borrowing $30 billion in the bond market.)

Yes, but: It's a different story altogether for "high yield" companies, or the companies with heavy debt loads and lower credit ratings. Borrowing activity for these companies has basically fallen off a cliff.

  • These companies had a much higher cost of capital, to begin with, and have less capacity to absorb extra costs. (The average high yield bond is now yielding about 7.5%, compared to 4.5% at the beginning of January.)
  • Most high yield companies refinanced their debts last year when money was cheap — so refi needs are low.
  • And now, volatile trading in both equity and debt markets has cooled leveraged buyout activity, typically a steady source of high yield bond placements.

In short, high yield companies are only tapping the bond market now if they absolutely need to, says Chris Blum, BNP's head of leveraged finance.

  • Worth noting: Despite the constraints, the default rate — a key indicator of overall corporate health and capital availability — remains historically low.

What to watch: If the Fed doesn’t stop at the expected 2 percentage points or so in rate hikes this year. In that scenario, the borrowing slowdown could spread to high grade companies, Forshner says.

  • A deceleration in M&A and other debt-fueled projects would likely follow, as higher borrowing costs mean some projects make less economic sense, he says.

The bottom line: "At some point, the cost of capital is going to have an impact on their investment decisions,” he adds.

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