Public and private companies felt the pinch of higher financing costs this year as the Federal Reserve raised its benchmark short-term interest rate. Now, with the Fed unveiling its seventh increase of the year, they are looking for clues on where rates might go in 2023.
The U.S. central bank raised the federal-funds rate by an additional half a percentage point, bringing it to a range of 4.25% to 4.50%, at the conclusion of its two-day policy meeting Wednesday. While that half-point increase marks a slowdown from a run of four consecutive 0.75 percentage point increases, Fed officials penciled in plans to raise the rate to between 5% and 5.5% next year. That forecast is up from September, when officials anticipated lifting it to around 4.6% by the end of next year.
Debt markets have declined this year amid the Fed’s monetary tightening campaign, with U.S. companies across the credit spectrum issuing $1.492 trillion in debt through Dec. 8, down 39% from the prior-year period, according to ratings firm S&P Global Ratings.
For finance chiefs, bankers and investors, the Fed’s statement and rate projection provide some clarity on future interest-rate changes—though persistent inflation still clouds the picture. “We are similar to others in that we’re looking for the Fed to help provide signals about their comfort level in the actions that they’ve taken in trying to moderate inflation,” said Kate Burke, the chief financial officer of AllianceBernstein LP, an asset manager.
Here’s how companies used different financing instruments in 2022 and what’s ahead for 2023.
Investment-Grade Bonds
Looking back: Top-graded companies were able to weather the rising-rate environment of the past year in good form. After a flurry of financing deals in 2021 when interest rates were low, highly rated companies went to the market less frequently in 2022 and opted for shorter-duration debt, often going out only five to seven years. A decline in mergers and acquisitions activity also contributed to the decrease, bankers said.
Investment-grade U.S. companies sold $855.81 billion in bonds through Dec. 12, down 17% from the prior-year period, according to Refinitiv, a data provider. “The quick pace of rate rises caused some participants to pause,” said
Dan Mead,
head of the investment-grade syndicate at
Bank of America Corp.
“They either pivoted to financing alternatives or were willing to wait until next year.”
Mondelez International Inc.,
the owner of Oreo cookies and other brands, in 2020 and 2021 refinanced large portions of debt at low cost, said finance chief
Luca Zaramella.
“Today, our average cost of capital is between 1.5% and 2%,” Mr. Zaramella said.
Looking ahead: With about $764 billion up for refinancing by U.S. investment-grade companies in 2023, analysts at BofA’s research arm expect deal volume to decline slightly compared with this year. “It is a pretty manageable maturity profile, and a large chunk of these maturities have already been refinanced,” said Mr. Mead.
Mondelez, for instance, doesn’t have significant maturities coming up and plans to use commercial paper should it be in need of additional capital, Mr. Zaramella said.
While finance executives at highly rated companies don’t like the increase in costs, it doesn’t cause a lot of worry, bankers said. “It’s more the sticker shock of where coupon rates are today and where they were in January,” Mr. Mead said, pointing to the changes in underlying Treasury rates and spreads.
High-Yield Bonds
Looking back: For a long time, loose monetary policy allowed companies facing distress to delay restructuring by accessing very favorable bank or bond financing, said Jason Kyrwood, co-head of finance at law firm Davis Polk & Wardwell LLP. But, Mr. Kyrwood added, “the thesis for highly levered companies doesn’t hold together when you’re paying a coupon of 11% or 12% versus 5% or 6%.”
Against this backdrop, high-yield-rated companies also sold less in bonds in 2022, which was in part because of the temporary closure of the market following Russia’s invasion of Ukraine in February and the volatility that ensued. Bond sales by high-yield U.S. companies amounted to $86.74 billion through Dec. 12, down 78% from the prior-year period, according to Refinitiv.
Looking ahead: Rising financing costs are causing a bigger problem for certain junk- or speculative-rated companies, as many of them watch their interest costs go up to 8%, 10% or even more and face potential cash flow declines as the economy weakens, bankers and other observers said.
The combination of higher interest payments and declining cash flows—especially in consumer-facing industries—will be a challenge for these companies, Mr. Kyrwood said.
S&P Global Ratings now expects the U.S. trailing-12-month speculative-grade corporate default rate to reach 3.75% by September 2023, from 1.4% a year earlier. “While speculative-grade maturities are relatively modest in the near term, those in upcoming years could pressure weaker credits that face challenging financing conditions,” S&P said in a recent note.
“Companies will be looking for greater market stability that creates a lower volatility environment where deals can get done,” said
Jason Elder,
a partner at law firm Mayer Brown LLP. “Not knowing the shape of the economic recovery, companies will continue to implement a prudent approach to balance sheet management and stay focused on liquidity in 2023.”
Convertible Bonds
Looking back: Sales of convertible bonds that can turn into equity declined sharply this year, with U.S. companies raising $25.6 billion with this tool through Dec. 12, down 66.6% from the prior-year period, when convertibles generated $76.6 billion in proceeds, according to Refinitiv.
Looking ahead: Activity in the convertible debt market has picked up in recent weeks, and some observers expect it to continue into 2023.
These instruments are more appealing to companies looking to raise capital as the conversion price for the convertible debt is at a premium to market price, so that the company is effectively selling stock at a higher price, said
Michael Kaplan,
a partner at law firm Davis Polk & Wardwell LLP. The conversion price is the par value of a bond divided by the number of shares for which it is exchanged.
The convertibles “market is open as a potential financing source for companies,” Mr. Kaplan said.
Syndicated Loans
Looking back: The syndicated loan market—in which several banks provide financing to one company or deal—has slowed this year as various take-private deals, including those of social-media platform Twitter Inc. and cloud-computing firm Citrix Systems Inc., have saddled banks with billions of dollars in debt for which they still haven’t found a buyer.
U.S. companies agreed to take out $2.622 trillion in syndicated loans through Dec. 12, down from $2.846 trillion during the prior-year period, Refinitiv said.
“The loan syndication market for leveraged buyouts is essentially closed because the banks were hung with so much paper,” said
Michael Moore,
a managing director at Union Square Advisors LLC, an investment bank.
Looking ahead: Although the market has been largely frozen, some bankers expect a thawing in the new year. “Lenders are getting indications that there will be some things coming in January,” Mr. Moore said, referring to the pipeline for syndicated loan deals.
Private Credit
Looking back: Private-credit transactions—which refer to funds provided directly by private lenders, bypassing bank syndicates—saw an increase in demand in 2022‘, not just from smaller and middle-market businesses, but also from larger companies, S&P analysts said in a recent note to clients.
“It will take some time for public debt markets to normalize, and private credit will continue to support financing to large corporate borrowers,” S&P said. However, with many of the financings structured as floating-rate deals, higher financing costs will likely have an impact on borrowers’ margins, S&P said.
U.S. companies borrowed $116.4 billion from direct lenders through Dec. 12, slightly up from $110 billion in 2021, according to KBRA Direct Lending Deals, a data provider. “What we’re telling our issuers right now is, if you don’t have to go out into this market right now, don’t go today,” said Mr. Moore.
Looking ahead: For middle-market companies backed by private-equity investors, the rise in benchmark rates and spreads brings significant changes, said Lawrence Golub, chief executive of Golub Capital, a direct lender to these companies. “CFOs have to be aware of that and focus on cash conversion and margins,” he said, pointing to the increase in financing costs.
Many deals between companies and direct lenders have to get refinanced every three to five years, said
Keith Miller,
global head of private debt at Apex Group Ltd., a financial-services firm. “We expect deals will continue to get done,” he said, adding that those could however come with more oversight from lenders.
But there is one area that could get tighter in the new year. While many of the companies that took out private credit in recent years have borrowed money with relatively few strings attached, lenders are expected to tighten their criteria in the coming year, Union Square Advisors’ Mr. Moore said.
Write to Nina Trentmann at [email protected]
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