$10 Trillion Later, Corporations Wake Up Today to a New Debt Era

Honeywell CEO: Not Changing Behavior on Fed Hike
  • Fed rate hike could spell trouble for the riskiest companies
  • Stock buybacks may decline, possibly crimping share prices

The man who runs Warren Buffett’s railroad worries what the Federal Reserve’s interest-rate hike will mean for his business, even if he thinks it’s the right call. Nissan’s Carlos Ghosn, by contrast, says it’s no big deal.

The reactions of executives like Matt Rose, executive chairman of BNSF Railway Co., and Nissan Motor Co. Chief Executive Officer Ghosn underscore how life is about to change for companies, for better or worse. Corporations have reveled in seven years of near-zero interest rates to make record-breaking acquisitions, refinance debt and even buy back their own shares with borrowed money. In the U.S. bond market alone, companies raised almost $10 trillion since the Fed first cut its benchmark target to zero in December 2008.

Matt Rose
Matt Rose
Photographer: Andrew Harrer/Bloomberg

That era of almost-free money is now starting to end, a transformation that will put pressure on companies to find new ways to grow and juice earnings as rates rise. The potential impacts are wide-ranging. An increase in borrowing costs could spell trouble for the riskiest companies that were propped up by low rates, and strain otherwise creditworthy firms that have loaded up on debt. Stock buybacks will likely decline, possibly crimping share prices. And the dollar could add to its recent gains, stinging exporters. Companies in the housing and auto industries that depend on low-cost financing could also be squeezed.

“We may have seen some of the best financing opportunities in a generation for a lot of corporations around the world,” said Jonathan Fine, who runs the investment-grade syndicate group for the Americas at Goldman Sachs Group Inc.

In reality, the 0.25 percentage-point increase in the central bank’s interest-rate benchmark isn’t going to amount to much for most corporate executives. What will matter is the pace at which the Fed hikes from here. Wednesday’s move brought the benchmark rate to half a percentage point, still a far cry from the four-decade average of about 5 percent.

Gerald O’Driscoll, a former vice president at the Dallas Fed, said he doesn’t expect companies to change their financing habits until rates hit about 1 percent.

If anything, corporate executives say, the rate rise signals a stronger economy and the start of a return to monetary normalcy.

“It’s time to raise interest rates,” said Gary Kelly, the CEO of Southwest Airlines Co. “You can’t have zero interest rates until infinity.”

Money-market interest rates reflected the Fed rate increase . The dollar London interbank offered rate was fixed at 0.3614 percent on Thursday, the highest since 2009.

Gradual Trajectory

In the bond market, the yield on the 10-year Treasury fell to 2.25 percent, reversing most of a rise after the Fed announcement on Wednesday. Yields declined in Europe on the outlook for a gradual trajectory of further Fed moves. Asian bonds rose for the third straight day.

Companies that rely heavily on exports aren’t so sanguine about the impact on their business as it potentially pushes the dollar higher.

"Our business always quite frankly runs better with a weaker dollar because of our exports," said Rose, whose Berkshire Hathaway Inc.-owned company delivers goods like cars, food and industrial gear for shipping abroad. It doesn’t help, he said, that Europe is keeping rates low to boost the region’s economy, weighing on the value of the euro.

The dollar rose for a sixth day on Thursday. The Bloomberg Dollar Spot Index, which tracks the U.S. currency against 10 major peers, climbed 0.4 percent as of 7:44 a.m. in New York. 

Nissan’s Ghosn said car sales won’t suffer because the hike has been well-telegraphed and will be gradual.

“If the second one comes, it means the global economy is in much better shape than what it is today," he said.

Unprecedented Stimulus

Corporate America had already taken steps in anticipation of the Fed’s action. When the central bank first signaled plans in 2013 to end its unprecedented stimulus program, the highest-rated companies issued record amounts of debt for back-to-back years to fund M&A, funnel money to shareholders and refinance debt. The goal was to lock in cheap borrowing costs before interest rates rose.

In many ways, the Fed is catching up with a turning cycle that has already seen investors pull back from lending to the riskiest companies. After oil drillers and miners loaded up on cheap debt when commodities were booming, plunging prices are making it difficult for them to refinance their borrowings. More recently, the investor aversion has spread to others that borrowed heavily, including retailers and drug makers.

Issuance by junk-rated companies has slowed this year after they raised an unprecedented $2 trillion of speculative-grade debt. Investors are demanding the most interest since 2009 for the riskiest borrowers, when the global economy was still recovering from the worst financial crisis since the Great Depression.

Stable Market

Still, some executives at risky companies welcome the Fed hike as a way to bring stability to capital markets. Jamie Pierson, chief financial officer of YRC Worldwide Inc., a U.S. trucker that restructured its debt at the beginning of 2014 to stave off bankruptcy, said it’s much more difficult for high-yield companies to raise money than six months ago. That should change now that companies and investors have more certainty, he said.

“The market hates volatility,” Pierson said. “I just want to know what the rates are going to be and let’s get on down the road.”

For companies with good credit, the risk of default is negligible. Yet their big debt loads mean that as of the second quarter they owed more in interest than they ever have, according to data compiled by Bloomberg. That has made it more expensive for them to borrow, a trend that could worsen with the Fed increase.

Average corporate borrowing costs rose to the highest in nearly four years earlier this week to 4.6 percent from a post-crisis low of 3.3 percent in 2013.

Mortgage Rates

The eventual end of inexpensive financing could hurt sales of such items as cars and homes, which have soared in recent years. But home-improvement retailer Lowe’s Cos. is betting the impact of somewhat less propitious financing conditions will be muted.

CEO Robert Niblock said mortgage rates would have to advance above 6 percent before home affordability weighs on the market -- a level not reached since 2008.

"A slight move by the Fed isn’t going to dramatically change people’s desire and willingness to invest in the home or buy a home," Niblock said.

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