Junk-rated firms beginning to feel the pinch

Big payback: Boeing aircraft at an assembly plant in the United States. Aerospace firms, housebuilders and those in healthcare and technology are seeing the highest rise in interest payments. — AFP

NEW YORK: Companies are feeling the pinch from a sharp jump in interest payments after global rate hikes, with S&P Global Ratings estimating that junk-rated firms are paying the highest interest on debt since 2010.

Speculative-grade firms are now paying an effective rate of 6.1% on average, up from 5.1% last year, according to a report by S&P. It’s a dynamic that’s likely to spur greater efforts by companies to slash debt and conserve cash.

“If funding costs remain higher for the long term, this may force a rethink of capital structures and bring more focus on protecting cashflows,” said Gareth Williams, of corporate credit research at S&P.

“We could see greater efforts to reduce net debt, more use of equity in mergers and acquisitions, and more caution over capital expenditure.”

As firms face the prospect of higher rates for longer in the coming months following a steep tightening cycle, those with business plans built during the last decade of cheap money are getting hit with a new reality. High-yield firms in particular are having to deal with the dual impact of costly payments from floating-rate debt and lower earnings.

Investment-grade companies are generally seeing a more gradual change in effective interest rates, to 3.7% this year from 3.4%, but even so their credit situation is showing early signs of deteriorating.

Higher financing costs coupled with waning earnings growth are causing a measure of corporate borrowers’ ability to pay interest on their debt to weaken, according to strategists.

The average junk-rated company is generating lower earnings relative to interest expense, according to Bank of America Corp (BoA) strategists, based on a measure of income known as earnings before interest, tax, depreciation and amortisation.

That ratio, known as the interest coverage ratio, has fallen after it peaked at around six times following the Federal Reserve slashing interest rates during the Covid-19 pandemic, BoA strategists led by Oleg Melentyev said. — Bloomberg

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