Beg, Sell Or Borrow

The first twinges of a credit crunch are hitting companies at the lower end of the corporate food chain. Beef up before the squeeze intensifies.

The days of easy, cheap financing are over. A perfect storm of rising interest rates, wider credit spreads amid economic turmoil and central bank quantitative tightening are squeezing junk-rated companies.

The last few years were an anomaly, according to Tony Carfang, managing director at The Carfang Group, a treasury consulting firm: “The favorable financing terms of the last two years were actually inconsistent with the long-term picture of the high-yield debt market.”

Companies that refinanced when the Covid-19 pandemic struck are sitting pretty—for now. As for corporates that need to refinance existing debt structures or find new financing deals, their options are getting thinner.

“[Lower-rated] corporates could enter a difficult zone given interest rates are picking up in the Eurozone,” says François Masquelier, the Luxembourg-based chair of the European Association of Corporate Treasurers. “Rising interest rates could be a factor in less easy access to credit.”

The financing squeeze is particularly pertinent for corporates that made acquisitions either earlier in the year or last year with the help of bridge loans, which are running out. A bond issuance would be the next obvious step, but that might be tricky. The number of companies issuing junk bonds this year has plummeted. Globally, 210 companies issued $111 billion of junk bonds during the first eight months of the year. That’s a huge drop from a year ago when 816 companies issued $500 billion, according to data provider Dealogic.

The fall is widespread across the US, Europe and Asia-Pacific partly because companies loaded up on debt in 2021 while it was relatively cheap. Therefore, they have no need to refinance in 2022. However, it is getting more expensive and therefore less attractive to issue new debt.

“Some of that pullback was natural—the pace of 2021 was unsustainable,” says Eric Rosenthal, senior director in leveraged finance at Fitch Ratings. “But the fact is that we’re looking at issuance that might be as low as where we were in 2008, which is pretty startling.”

The sterling corporate bond market, for example, is “dead.” That’s according to one bearish head of investment banking at a French bank in London. A corporate’s first port of call is their bank to extend their bridge loan or set up a temporary credit facility until they can issue a bond, he explained.

Sell to Swell the Company Coffers

Another option for under-pressure corporates in need of capital is to undertake a strategic review and consider selling assets. The default rate for junk-rated borrowers is set to increase. After nursing heavy losses this year, banks are cooling on the riskier companies on their books.

US and European banks are slated to lose more than $5 billion over risky buyout loans. Major US lenders Bank of America and Citigroup wrote down €1 billion on leveraged and bridge loans in the second quarter alone, reports Reuters.

Wells Fargo wrote down $107 million on unfunded leverage finance commitments when widening market spreads burnt the bank. The third-largest bank by assets in the US notched up a $576 million “impairment of equity securities” after the market downturn in the second quarter hurt its venture capital business. Fitch predicts the default rate for high yield bonds will double to 1% this year in the US and 1.5% in Europe and rise further to between 1.25%-1.75% and 2.5% in 2023, respectively.

Shoppers are tightening their belts as hard times hit, putting pressure on companies that loaded up on debt in the good times but are yet to turn a profit. In 2021, Just Eat was riding high after buying US rival Grubhub for €7.3 billion to grow its share of the competitive food delivery market. A year later, in a reversal of fortunes, the takeout giant is scrambling for cash.

In August, barely a year after it inked the deal to buy Grubhub, Just Eat wrote down €3 billion off its acquisition. It then sold its stake in lucrative Brazilian delivery app iFood for €1.8 billion to bolster its balance sheet and pay down debt.

“We will see more of those kinds of restructurings or spinoffs that allow a company to raise equity or improve the structure of its balance sheet,” Carfang says. “If you’re buying time, those things might work. But there’s a limit to what those things can do. You spin off until you’re naked and then what are you going to do?”

Financing conditions will only get tougher, predict experts, as central banks unwind years of loose monetary policy. The Bank of England is planning to sell around £200 million of corporate bonds a week, which will add up to £10 billion a quarter, as part of its stimulus unwinding plans. Quantitative tightening has already begun in the US, with the Federal Reserve working to halve its $9 trillion balance sheet over the next four years.

Stagflation—a triumvirate of high inflation, joblessness and an ailing economy—is also a growing threat for lower-rated borrowers, particularly those in Europe, the Middle East and Africa. This comes down to lower economic growth in Europe, exacerbated by idiosyncratic shocks like Brexit, and fewer corporates in well-performing sectors like commodities.

“Risks are building up in sectors vulnerable to inflation and pull-back in consumer demand,” Fitch Ratings senior director Lyuba Petrova says. “European leveraged finance issuers have less cushion relative to their US peers.”

Be a Smart Borrower

Corporate treasurers and finance directors need to be nimble in order to tap capital markets for funding during volatile times. “We’re not seeing any indication that markets are going to relax,”says Sarah Boyce, associate director in the policy and technical team at the UK’s Association of Corporate Treasurers. “This feels likely to be the new normal for a while.”

But, she adds, companies must be well prepared to dive in at the moment conditions look favorable. “Markets will open for very short periods, so you need to be prepared to press the button,” she says. “You don’t want to start the process when the market opens. You want to be ready to go. The last thing you need is to figure out that you need board approval and that it’s going to take six weeks, because in that time the market could have opened and closed.”

Struggling corporates looking to issue debt or equity may seek out private players for help getting over the finishing line. Earlier this year, second-hand car seller Carvana turned to Apollo Global Management to stump up around $1.6 billion towards its stalled $3.3 billion bumper bond to fund an acquisition. It came at a cost: a yield of 10.25%.

Meanwhile, corporates can work on optimizing cash management procedures, such as bettering invoicing terms and shoring up trapped cash sitting idly in international subsidiaries. Now is the time for corporates to squeeze their existing relationships for maximum gain. “Focus on your existing financial supply chain relationships,” Carfang says. “Go to the bank that you’ve given the most business to in the past. Go to the bank who knows you. Go to the banks that understand your industry and therefore may not be quite as draconian on the credit spreads that they charge.”

“Go to the banks that might appreciate the ancillary business, like the cash management business that you can give them to help compensate for the risk, as opposed to starting a brand-new relationship altogether—because those are going to be expensive.”