Companies are borrowing record amounts of money just as their revenues are falling and the economy looking like its heading into recession. Most of that borrowed money isn’t for capital expenditures, it’s for financial engineering, which amounts to financial speculation. Conceivably interest rates could rise, too, but what’s the worry? From Wolf Richter at wolfstreet.com:
Companies with investment-grade credit ratings – the cream-of-the-crop “high-grade” corporate borrowers – have gorged on borrowed money at super-low interest rates over the past few years, as monetary policies put investors into trance. And interest on that mountain of debt, which grew another 4% in the second quarter, is now eating their earnings like never before.
These companies – according to JPMorgan analysts cited by Bloomberg – have incurred $119 billion in interest expense over the 12 months through the second quarter. The most ever.
With impeccable timing: for S&P 500 companies, revenues have been in a recession all year, and the last thing companies need now is higher expenses.
Risks are piling up too: according to Bloomberg, companies’ ability pay these interest expenses, as measured by the interest coverage ratio, dropped to the lowest level since 2009.
Companies also have to refinance that debt when it comes due. If they can’t, they’ll end up going through what their beaten-down brethren in the energy and mining sectors are undergoing right now: reshuffling assets and debts, some of it in bankruptcy court.
But high-grade borrowers can always borrow – as long as they remain “high-grade.” And for years, they were on the gravy train riding toward ever lower interest rates: they could replace old higher-interest debt with new lower-interest debt. But now the bonanza is ending. Bloomberg:
As recently as 2012, companies were refinancing at interest rates that were 0.83 percentage point cheaper than the rates on the debt they were replacing, JPMorgan analysts said. That gap narrowed to 0.26 percentage point last year, even without a rise in interest rates, because the average coupon on newly issued debt increased.
And the benefits of refinancing at lower rates are dwindling further:
Companies saved a mere 0.21 percentage point in the second quarter on refinancings as investors demanded average yields of 3.12 percent to own high-grade corporate debt – about half a percentage point more than the post-crisis low in May 2013.
That was in the second quarter. Since then, conditions have worsened. Moody’s Aaa Corporate Bond Yield index, which tracks the highest-rated borrowers, was at 3.29% in early February. In July last year, it was even lower for a few moments. So refinancing old debt at these super-low interest rates was a deal. But last week, the index was over 4%. It currently sits at 3.93%. And the benefits of refinancing at ever lower yields are disappearing fast.
What’s left is a record amount of debt, generating a record amount of interest expense, even at these still very low yields.
To continue reading: Wrath of Financial Engineering
