Borrowing costs

How higher borrowing costs are hitting U.S. businesses

Data: Commentary and leveraged data;  Graphic: Erin Davis/Axios Visuals
Data: Commentary and leveraged data; Graphic: Erin Davis/Axios Visuals

It’s been five months since the Federal Reserve began hinting that it was about to raise interest rates, and two since its first hike – so now is a good time to check how the policy change monetary policy is changing the borrowing habits of American businesses.

Why is it important: The Fed’s job is to make money more expensive – and that’s supposed to limit borrowing and slow the economy.

How are you: Well, big companies with solid finances – meaning piles of cash and manageable debt loads – hardly took the plunge. These “high-end” companies have borrowed almost as much so far this year as they did during the same period last year – and that was a record.

  • Even though borrowing money in the investment-grade bond market now costs about 2 percentage points more than it did at the end of last year, large companies with good balance sheets can absorb that extra cost quite easily, says Chris Forshner, Head of Premium Finance at BNP Paribas. .
  • As a result, blue-chip companies haven’t really slowed down when it comes to refinancing — or mergers and acquisitions, much of which is debt-financed. (For example, Discovery bought WarnerMedia by borrowing $30 billion on the bond market.)

Yes, but: It’s a whole different story for “high yield” companies, or companies with high debt and lower credit ratings. The borrowing activity of these companies has virtually fallen off a cliff.

  • These companies had a much higher cost of capital to begin with and have less capacity to absorb the additional costs. (The average high yield bond is now giving about 7.5%compared to 4.5% at the beginning of January.)
  • Most high-yield companies refinanced debt last year when money was cheap – so refi needs are low.
  • And now the volatility of trading in equity and debt markets has cooled leveraged buyout activity, generally a regular source of high yield bond investments.

Short, High-yield companies only tap into the bond market if they absolutely need to, says Chris Blum, head of leveraged finance at BNP.

  • To note: Despite the constraints, the default rate – a key indicator of overall corporate health and capital availability – remains historically low.

What to watch: If the Fed doesn’t stop the expected 2 percentage points in rate hikes this year. In this scenario, the slowdown in borrowing could spread to blue-chip companies, Forshner says.

  • A deceleration in mergers and acquisitions and other debt-fueled projects would likely follow, as higher borrowing costs mean some projects make less sense economically, he says.

The bottom line: “At some point, the cost of capital is going to have an impact on their investment decisions,” he adds.