When it comes to refi penalty and roll risk, it was always (and self-evidently) a matter of how long the Fed holds terminal.
The steeper your maturity wall, the less runway you have in that regard. If your funding mix depends heavily on floating-rate debt, you don’t have much runway at all.
The March SEP tipped the same three rate cuts for 2024 as December’s dot plot, but that’s not a lot of implied relief. And notwithstanding now unfashionable “sudden stop” macro narratives, it seems highly unlikely that Jerome Powell will be forced into a rapid, aggressive rate-cutting campaign anytime soon. If he is, it likely means something very bad’s happened, and it’s a rare occasion when very bad things happen and junk-rated borrowers aren’t disproportionately impacted.
Given all of that, it’s fair ask if “lesser” corporates might yet face a reckoning. “Might yet,” because it wasn’t so long ago (where that means two weeks ago) when I declared the maturity wall panic bear narrative dead. Certainly, it’s less frightening now than it was thanks to spread compression witnessed over the course of the five-month risk asset rally.
And yet, according to TD, trailing 12-month default rates on US leveraged loans are inching further beyond 6% perhaps on their way to levels consistent with historical recessions (so, near 8%). At the same time, debt coverage ratios have deteriorated meaningfully, with just 42% of borrowers in a universe tracked by Apollo boasting a ratio of 4.0 or better, the smallest share in at least seven years.
The simple figure below from SocGen works as a kind of bird’s eye perspective.
Note that the interest cost series (in red) is plotted on a five-quarter lag. If past is precedent, interest burdens should start increasing rapidly right around… well, right around now.
“Interest cost follows the trajectory of real interest rates with a lag, and this cost should start to rise, leading to lower profitability,” the bank said this week.
Of course, there are all manner of mitigating factors this cycle, not least of which is the extent to which corporates were able to term-out their debt profiles at extremely favorable rates in 2020 and 2021. But in the context of junk-rated borrowers, that’s an exercise in question-begging: They rely more on shorter-maturity debt and floating-rate obligations.
The cost of capital won’t stay elevated in perpetuity, of course, but it’s all relative. If your maturity wall’s too steep, a couple of years can feel like “perpetuity.” And as alluded to above, the problem with praying for rate cuts if you aren’t a blue-chip is that the conditions which trigger aggressive central bank easing are generally the same conditions which prompt sharply wider spreads.
