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Capital Markets

Looming Refunding Strains Threaten Corporate Debt

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February 21, 2019

Moody’s: Economic slowdown would exacerbate structural refunding challenges

BenjaminsHigh-yield bond issuance has recovered from its December slump, but structural impediments could still create challenges for investment-grade and speculative-grade companies looking to refund bond and bank debt over the next few years, especially if the economy sours.

“Eventually the economy will turn and these companies will need to refinance,” said Chris Padgett, head of leveraged finance research at Moody’s Investors Service. And at that point, “the climate will be more difficult.” In this case, defaults would start to pick up. Currently, default rates are stable and, in some cases, declining, and that trend should remain for at least another year, according to Moody’s research. Ms. Padgett says that many companies refinanced in the last year, “so there hasn't been a big default wave.” But will likely change in the next year or so as the need to refinance picks up.

And it is that looming wall of refunding that has experts worried. Moody’s recently published reports noting that the volume of investment-grade and speculative-grade corporate debt maturing over the next five years is at or near all-time highs, in each case just topping $1 trillion. That increases refunding risk compared to last year, because rates and volatility have increased, and there’s a greater likelihood of an economic slowdown that would dampen lenders enthusiasm.

On the speculative-grade side, companies face $43 billion in maturities this year, relatively little compared to $111 billion next year and $392 billion in five years, but still the record high Moody’s has recorded in the first year of the five-year window.

“Treasurers will need to consider their cost of capital and ability to access the market,” said Anastasija Johnson, senior analyst covering speculative-grade refunding risk at the ratings agency. “If economic and market conditions worsen, it might be harder for lower-rated companies to access the market.”

Economic slowdowns and the often-accompanying volatility tends to push investors to flee to higher-quality assets, and consequently investment-grade companies traditionally less trouble obtaining or refunding debt at reasonable prices. That will likely still hold true over the several years, relative to speculative-grade debt. However, the record volume of maturities in the next five years that likely will have to be refinanced is problematic for both market and company-specific reasons.

The volume of investment-grade maturities at the end of 2018 was up only 2% over the year before compared to a 6% increase for speculative-grade companies, but it’s still a record amount that must be refunded by those companies, and financial-market volatility and possibly rising rates could increase costs. On a company specific basis, the percentage of companies rated Baa, the lowest investment-grade broad rating category, increased to 52% at year-end compared to 49% last year.

That means more investors must willing to take the risk of investing in credit that’s one level away from speculative grace, although debt rated Baa3—the lowest rung of the Baa category—remained unchanged at 15%.

“Both market-specific risk and company-specific risk have increased, and in the event of further weakening, it would be more difficult and costly to refinance,” said Natalia Gluschuk, a Moody’s analyst covering investment-grade refunding risk. “Near-term maturities would be particularly exposed to any unprecedented market shutdowns, in which case liquidity considerations and balance sheet cash to be able to address maturities would be of importance.”

US speculative-grade bond issuance has picked up after a draught at the end of last year. The slump in November and December occurred after Federal Reserve Chairman Jerome Powell suggested rates would continue to raise, and Moody’s Three-Year Refunding Indicator—calculated by multiplying the 12-month trailing issuance by three and dividing the product by the outstanding maturities--fell to 2.3, a drop 47% from the year before and 61% below the long-term average of 6 times.

When Mr. Powell softened that stance in early January, bond issuance resumed, although the $16 billion in speculative-grade issuance in January was well below the $24.6 billion a year ago, according to Dealogic. In addition, the Wall Street Journal reported on February 4 that several issuers offered secured bonds, which carry more protections for investors and provide more security in the event of an economic downturn.

The Moody’s report suggests that refunding challenges could be amplified beyond what’s apparent in the numbers by the so-called pull-forward effect. That occurs what a company refunds several maturities at once, in a single loan, when the first one comes due.

“We estimate the pull-forward effect could increase near-term bank credit maturities by 74% to $258 billion through 2021, from $145 billion,” the report says.

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