Posted by Lawrence Gillum, CFA, Fixed Income Strategist
Tuesday, October 25, 2022
With the aggressive front loading of rate hikes we’ve already seen from the Federal Reserve (Fed) this year, yields on Treasury securities are at multi-year highs. Moreover, since Treasury yields are generally used as the base rate for consumer and corporate borrowers, the increase in Treasury yields this year pushed borrowing costs for many borrowers to levels not seen in years. Consumer loans such as mortgage rates have already repriced higher and have been a big reason affordability has fallen in the housing market. And for corporate borrowers, after years of borrowing at ultra-low rates, the backup in yields we’ve seen this year has pushed corporate borrowing rates back above 6%, which is the highest levels since 2009. As higher borrowing costs have reduced the affordability and activity we’ve seen in the housing market, could higher borrowing costs for corporates reduce profitability and potential growth opportunities as well?
Perhaps, but over the last two years in particular, corporate borrowers have increased the amount of new debt issued seemingly to prepare for the rising rate environment we’re currently in. In fact, new corporate debt issuance for investment grade companies hit record highs in 2020 and 2021 when over $3 trillion of new debt was issued. As such, corporate entities were able to term out debt by issuing a lot of debt at longer maturities and at lower rates. And now that interest rates have moved higher this year, 2022 new debt issuance is on pace for the lowest levels in years. With still elevated cash levels for larger cap companies, it seems corporations don’t need to access the capital markets as much as they have in years past.
Also and importantly, because companies were able to refinance existing debts over the last few years and push out maturities, only about 1% of existing debt needs to be refinanced in 2023, and less than 10% needs to be refinanced before 2025. Again, the need for companies to refinance existing debt at these higher levels seems to be muted currently.
The move higher in Treasury yields this year has been swift and unrelenting and has pushed borrowing costs for countries, consumers, and companies to multiyear highs. While higher consumer loans have no doubt hit the housing market hard, reducing affordability for potential buyers, the impact on corporate borrowers is still mixed. Yes, new issuance by companies will be at these higher rates but companies, in aggregate, did a good job of taking advantage of the low rate environment over the past few years and locked in lower rates. With cash balances still relatively elevated and without the pressing need to refinance existing debt, we don’t think potential growth opportunities or corporate profitability will be negatively impacted in the near term. That said, if the Fed is able to keep rates at these elevated levels and as the need for corporate borrowers to access the capital markets increases, no doubt corporate profitability will be negatively impacted by higher interest expenses. We don’t think it happens in the near term though.
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