High-yield companies are accepting that rates may stay higher for longer
Companies in the US with lower credit ratings are starting to accept that interest rates may not drift lower anytime soon. That means a growing number of them are beginning to refinance debt and tap the bond market, rather than holding out and hoping the Federal Reserve will cut rates, says Christina Minnis, head of Global Credit Finance and head of Global Acquisition Finance in Goldman Sachs Global Banking & Markets.
High-yield company bonds yield around 9%, more than double the rate two years ago. At the same time, a significant amount of debt matures in the coming years, particularly around 2028. Executives will start refinancing those bonds and leveraged loans well before the maturity wall closes in, Minnis says. She also points out that some public borrowers may look to convertible notes — debt with an option to be converted to equity — to lower their interest expense.
Companies are getting used to “a paradigm where we're living in this rate environment,” Minnis says. “And by the way, this is a rate environment we've lived in many, many times before. This this is not anything to be too concerned about.” We spoke with her about how companies with lower credit ratings are handling the rise in interest rates, risks as the maturity wall approaches, and her outlook for the coming year.
Are corporations coming around to the idea that interest rates are going to be higher for longer?
Christina Minnis: I do think we're going to start to see more corporate issuance based on the realization that the rates are probably going to be higher for longer. There's a general view it’s going to be at least one to two years of higher rates, if not longer. And so with that backdrop, I think corporates are basically saying the expectation that the Fed may cut soon is probably not there.
So what that will mean is corporates are going to start availing themselves of longer term capital and looking at duration. You'll see a pickup in corporate activity.
One of the bigger drivers of leveraged finance is M&A and also sponsors. And so to see a real pickup in volumes, we need to have the sponsors kick in, as well as corporate M&A. And I think we're starting to feel better that corporates are going to get more acquisitive.
How do refinancing needs differ in the near term versus the medium term when the so-called maturity wall starts to approach?
There's a very large bubble of debt in around 2028. Starting in 2025 and 2026 you start to see it pick up gradually, and it's not a small number.
So there is time, but that's not an inconsequential amount, particularly if you start to have some more M&A activity. And normally, clients don't wait until the year in advance of a maturity. Normally, the below-investor-grade market will finance one-and-a-half to two years ahead of a maturity. They won't usually run it out until the maturity is current in their financial statements.
With 2025 and 2026 starting to come into sight, I think you're going start to see those maturities get addressed coming into the first quarter of 2024.
Are companies that issue high-yield bonds and leveraged loans able to absorb these higher interest rates? Does it differ for higher rated companies, in the BB range, versus targets of leveraged buyouts that might be riskier?
The public, BB rated companies have leverage, but their balance sheets are much healthier than in the leveraged buyout space.
The private LBOs took on debt when rates were very low and their loans are all floating rate. And now their average borrowing is up by 400 to 500 basis points. And that's what made those types of credits need to go out and actually add equity-type capital and take down the burden of debt.
Very few public companies live life that levered, so they can absorb higher rates. Their balance sheets are much healthier.
That being said, I think public companies are starting to look at the convertible market. Depending on their view of their stock price and the sector, doing a convertible can really offset the cost of higher interest expense, because they obviously get paid for the volatility and the call option they're offering the investor, and so the base rate tends to be a lot lower than a fixed rate instrument. There are a lot more tools in the toolkit for a public BB, per say, than a very levered private LBO.
What are the risks for companies considering a wait-and-see approach, in hopes that rates will fall?
My personal view is that sponsors, ever since the spike in rates, have been kind of hoping that we'd see a really accommodative Fed potentially somewhere in the back half of this year, and clearly in 2024. And so they were sort of kicking the can a bit on some of these decisions. But people now are realizing the chance of rates staying higher are probably higher than the chance of the Fed easing. What that means is as soon as they see windows of opportunity to refinance they’re going very quickly.
A bunch of sponsors are now jumping in because recent order books were multiple times over-subscribed. There's not a lot of supply. So they’re getting their deal refinanced. We've seen a lot of opportunistic folks trying to amend and extend the maturity of term loans. They’re trying to cut the spread (the extra interest paid in addition to the risk-free rate). Or if they've got a low spread with a short duration, they’re trying to extend the maturity.
It's going to be very, very busy in the next two to four weeks.
Analysts in Goldman Sachs Research suggested in a report that there can be spillover from higher interest expense, resulting in lower corporate capital expenditures. Is that something you’ve seen historically?
A company only has so much cash flow. You’ve got to pay interest expense. You’ve got to obviously support your working capital. You’ve got to pay your taxes. And then what is discretionary? Sometimes you would say growth capex can be discretionary.
Whether it's cutting back on travel to conferences for people who aren't presenting, or not investing in the opening of an office — that's what companies have to do. They have a finite amount of cash flow and a bigger chunk of it is going to pay interest expense right now. Most companies don't want to go cash flow negative, so I think they are probably rationing everything from, what they deem to be discretionary, operating expenses — hiring, travel, and entertainment — to capex.
What else is on your mind as we look out for the next six to 12 months?
I think you're going start to see corporates just having to get themselves back into a paradigm where we're living in this rate environment. And by the way, this is a rate environment we've lived in many, many times before. This this is not anything to be too concerned about.
Meanwhile, some sponsors were very conservative. Some sponsors hedge the majority of their floating-rate book. They just don't believe in not being hedged. Some sponsors didn't do any hedging. So those sponsors are going to have very, very different outcomes in their portfolios, to your point, with their ability to use cash flow, and to grow, invest, and pay dividends.
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