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Big US companies are careful about the timing of their bond sales, as a general rule.
In the years after the financial crisis, investment-grade companies would stop selling bonds when Treasury yields went up, and start again when yields fell. Pretty simple, really.
So what should we make of the fact that companies are still selling plenty of investment-grade debt while the 10-year Treasury yield climbs to 4.2 per cent, close to 15-year highs?
It seems reasonable to think this means companies don’t expect yields to fall any time soon.
Bank of America’s credit strategists point this out. In a note this week they highlight that their rates team forecasts the 10-year yield will trade around 4 per cent at the end of this year, and 3.5 per cent at the end of 2024 — and stay at those levels through the end of 2025, too.
On one hand, this would mean there won’t be a big recession that forces the Fed to cut rates next year, which would be good!
Over the longer term, however, this could test corporate borrowers’ tolerance for higher rates.
In a prior note from late July, BofA looks at the historical relationship between US rates and interest-coverage ratios — a company’s earnings before interest and taxes divided by its interest expense — and finds about two years of lag time between a rise in rates and a decline in companies’ interest coverage:
Higher for longer US policy rate could make a dent in the IG corporate market coverage ratio. Historically, the coverage ratio followed interest rates with about a two-year lag. That makes sense due to 1) interest rates are much more variable than debt levels and 2) it takes time for old debt to roll off. Based on this historical relationship the current 10yr Treasury yield of about 4% implies IG coverage ratio of about 10x in 2025, down from 11.9x as of 1Q-2023. That would be just 13th percentile since 2010 (when interest rates were relatively low), but 37th percentile for the full history going back to 1Q-1997 . . .
But that’s just based on the history. What if investment-grade companies’ borrowing costs stay near current levels (with the index yielding 5.5 per cent) for the next two years?
All else equal, those companies’ ability to cover interest costs could fall to the lowest level since 2003, BofA found:
However, we estimate that rolling maturing debt at the current IG index yield of 5.5% (and assuming no change in debt or earnings) would take the coverage ratio to 10.3x by YE-2024 and to 8.7x by YE-2025. Hence, should interest rates remain high for the next two years, the US IG corporate coverage ratio could drop to some of the lowest levels since 2003.
Hasn’t seemed to affect companies’ appetite for borrowing this month, at least.
