Fed hikes are bad news for cash-starved companies
Surging borrowing costs are making it tougher for struggling companies to raise new capital — a big shift from the last few years of unusually easy access to markets. It's also changing the deal calculus for private equity funds that buy companies using as much borrowed money as they can.
Why it matters: These are examples of how rising rates ripple out into the markets and the lending ecosystem. And when the credit spigot slows, the riskiest borrowers are the first to get choked off.
Driving the news: Revlon filed for bankruptcy this week, finally capitulating after staving it off for years with a string of debt-extension deals. (And who can forget the infamous "fat-finger" incident in which Citigroup accidentally paid off a Revlon loan — at full value — that had been trading at 30 cents on the dollar?)
- Revlon has long been a "zombie"-type company, able to operate but not pay off debts or invest in growth. The end of the easy money era may be the catalyst that drives more zombies into bankruptcy court.
State of play: Last Friday’s inflation report kicked off a re-pricing throughout the credit world, as the benchmark Treasury note hit an 11-year high — and everything else followed suit.
- The average yield on high-yield (aka non-investment grade) bonds has surged by more than three-quarters of a percentage point since then, to 8.25%. With the exception of a brief window at the beginning of the pandemic, that’s the highest it’s been since 2016.
- The riskiest subset of high-yield bonds — those with the lowest “CCC” ratings — shot up by a full percentage point, to 14%.
The impact of this volatility splinters out in a few different ways. For one, it inhibits virtually any company with rock-bottom "CCC" ratings that needs to raise money.
- “The rise in borrowing costs impacts companies that need regular access to capital every couple of years,” says Roberta Goss, senior managing director and head of the bank loan and CLO platform at Pretium.
Yes, but: The good news is that thanks to the flow of cheap money throughout 2021, few high-yield companies face a make-or-break need to raise cash in the next year or two.
In the private equity world, leveraged buyouts are often backed by high-yield bonds — but some buyouts won't be sound if a chunk of their capital costs 14%. More equity, less debt, is the theme of the moment.
- “If a ‘CCC’ bond is going to be 13% or 14%, that really changes the math for private equity sponsors. It's really hard to make it work,” Christopher Miller, senior analyst and director of capital markets at Neuberger Berman, tells Axios.
Where it stands: High-yield placements have slowed to a trickle, with the window opening for brief bursts like the first week of June — before that grim CPI report.
- Prior to that, the market was pretty closed for a time: Just $4 billion worth of deals priced in May (compared to an average of $39 billion per month in 2021), according to deal data provider LCD. None of May's deals were "CCC" rated.
What to watch: There may be brief periods where the window is open for lower-rated deals — but until inflation breaks and the Fed can ease back on its tightening campaign, that window will be closed far more often than it's open, says Bill Zox, high-yield portfolio manager at Brandywine Global.