Breakingviews: Fed rate hike foretells end of credit-market boom

Published Thu, Dec 15 20163:09 PM ESTUpdated Thu, Dec 15 20163:30 PM EST

Breakingviews

Tom Buerkle

Borrowing becomes less attractive when interest rates start rising from almost nothing. The Federal Reserve's interest-rate hike on Wednesday – only the second in a decade – foreshadows the end of a debt binge by U.S. corporations. Real growth rather than financial engineering will be the new game as lenders charge more. Cheap debt has been a potent salve for companies struggling to get ahead in a slow-growth world. U.S. corporate bond issuance is on track to set a record for the fifth straight year, with $1.45 trillion in new bonds offered as of Nov. 30, according to the Securities Industry and Financial Markets Association. The money raised has financed a spate of merger activity, enabled companies to boost earnings per share with buybacks, and substituted cost-effectively for paying tax to repatriate profit earned overseas. More from Breakingviews : New president may force hawkishness on 2017 Fed Even before the Fed lifted overnight rates to 0.5-0.75 percent, the credit cycle was showing its age. The median debt level of investment-grade non-financial companies has risen to three times EBITDA, equaling the peak seen at the height of the financial crisis, according to Standard & Poor's. Typical leverage exceeds five times EBITDA for high-yield borrowers, a record high. About 5 percent of junk-rated companies are defaulting each year, a level usually seen only around recessions, although the recent rise in oil prices should ease strains on the energy sector. Debt service isn't yet a big problem. Many companies used the bond boom to extend maturities, and rates remain at historically low levels even after the post-election spike in, for instance, 10-year U.S. government bond yields to more than 2.5 percent. However, both underlying benchmark rates and the extra that lenders demand to compensate for credit risk are poised to rise. Yield spreads on bonds rated single-A have narrowed to just 105 basis points over Treasuries from 164 bps in February, according to Bank of America Merrill Lynch , while high-yield spreads have dropped by more than half over that period, to 420 bps. These tightly coiled springs will expand sharply if the Fed follows through with its projected three rate hikes in 2017 and bond investors become more conscious of credit risk. The economy and most companies will be fine if rising rates coincide with strengthening growth and earnings. But it won't be so easy to use debt to cover up for their absence. For more independent commentary and analysis from Reuters Breakingviews, visit breakingviews.com

Janet Yellen speaks during a press conference following Fed's interest rate announcement in Washington, on December 14, 2016.

Samuel Corum | Anadolu Agency | Getty Images

Cheap debt has been a potent salve for companies struggling to get ahead in a slow-growth world. U.S. corporate bond issuance is on track to set a record for the fifth straight year, with $1.45 trillion in new bonds offered as of Nov. 30, according to the Securities Industry and Financial Markets Association. The money raised has financed a spate of merger activity, enabled companies to boost earnings per share with buybacks, and substituted cost-effectively for paying tax to repatriate profit earned overseas.