U.S. Corporate Borrowers Face High Refinancing Risk Amidst Elevated Funding Costs

According to a report by Moody's Investors Service, U.S. corporate borrowers are bracing for significant refinancing risk in the coming years. This concern comes at a time when funding costs are at their highest point in 13 years due to stubborn inflation pushing interest rates up. As a result, companies will have to bear the burden of increased costs when rolling over their debt.

The report reveals that issuers of nonfinancial speculative-grade, or high-yield, debt are confronted with a staggering $1.87 trillion of debt maturing between 2024 and 2028. This figure marks a 27% increase from the previous record of $1.47 trillion published in last year's report, encompassing the period from 2023 to 2027. Moody's has meticulously analyzed the refinancing risks and requirements of U.S. speculative-grade issuers through a series of 26 reports.

This impending "maturity cliff" intensifies default risk and contributes to the climbing default rates. Moody's projects that the U.S. speculative-grade default rate will reach its peak at 5.6% in January 2024, gradually tapering down to 4.6% by August 2024.

The surge in default rates can be attributed, to some extent, to the large maturities scheduled for 2028, primarily consisting of leveraged loans. Additionally, the inclusion of debt issued by non-U.S. subsidiaries for the first time also contributes to this increment.

The cumulative total of maturities in 2028 amounts to a staggering $560 billion as a result of the record issuance of leveraged loans in 2021, which typically possess seven-year tenors.

Moody's commented, "These increases surpassed the declines in maturities resulting from refinancing, debt repayment, and rating upgrades to investment grade since last year's study. High interest rates and limited market access inhibited the amount of refinanced debt ($414 billion) and new issuance ($242 billion) compared to last year's study."

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The report highlights that the "pull-forward" effect and "amend-and-extend" activity are exacerbating the refinancing risk for leveraged loans. Companies' inclination to refinance multiple layers of debt within a single bank credit agreement when the initial tranche (typically a revolver) becomes due could potentially double their bank debt maturities between 2024 and 2026, surpassing $1 trillion in total. This would represent 80% of all five-year bank maturities.

This paradigm presents a challenging landscape for U.S. corporate borrowers as they grapple with elevated funding costs, increased refinancing risk, and mounting default rates.

Rising Risks in the Debt Market

Moody's has reported that there is an increasing concern in the debt market due to a higher amount of debt maturing from lower-rated issuers. Specifically, the single B category accounts for 62% of total maturities, while the lowest-rated issuers, those rated Caa to C, hold 11% of maturing debt. This poses a significant risk as these companies may struggle to refinance their debt at affordable interest rates.

On top of that, there is a notable increase in the proportion of maturities from distressed companies, with 19% of 2024-25 maturities being from companies rated Caa and lower. This is up from 16% in the previous study and further highlights the challenges they face in refinancing their debt.

Looking at the breakdown by sector, technology, media, and telecom companies have the highest percentage of maturities at 23%, followed by services at 22%. This indicates that these industries will face considerable refinancing pressure in the coming years.

To illustrate the severity of the situation, data-solutions provider BondCliQ Media Services has provided a chart showing the steep increase in upcoming maturities. Additionally, high-yield issuers, who were able to sell debt at relatively low interest rates during a period of zero interest rates, are now facing higher borrowing costs of up to 12%.

In the investment-grade world, risks are also rising as nonfinancial investment-grade bond issuers face a 12% increase in five-year maturities. A staggering $1.26 trillion of debt is set to mature between 2023 and 2028, with the majority of it due in 2025. Despite this, Moody's believes that investment-grade companies will still be able to access the bond market and manage the higher interest costs due to their good cash flow.

However, it is important to note that higher interest rates will have a negative impact on funding costs and add to existing credit risks. As a response, companies are adopting strategies such as shortening tenors on new debt and reducing duration risk.

In September, investment-grade issuance has already seen a 20% increase compared to the same period last year. This increase has pushed the percentage of maturities within the first three years of the five-year scope to 61%, up from 58% last year.

Overall, the debt market is facing various challenges, with rising refinancing risks and increasing funding costs. It remains crucial for companies to carefully manage their debt and adapt to the changing market conditions.

Read: A wrecking ball could hit leveraged loans if the Fed keeps rates high