While most data continue to suggest the U.S. will suffer only a shallow recession this year--with some signs even pointing to a possible economic soft landing--U.S. corporate borrowers are facing operational and financing headwinds that will weigh on debt-service capacity, S&P Global Ratings said in a report titled "U.S. Corporate Credit Outlook 2023: Profit Pressures, Refinancing Risk."
We expect profit pressures on U.S. nonfinancial corporates borrowers to intensify, at least in the near term. Many companies will find it more difficult to balance still-elevated input costs and waning demand amid the prospects of a downturn in the world's largest economy and diminished consumer purchasing power, especially at the lower end of the income scale. Already companies in some consumer-dependent sectors are being forced to offer steep discounts after having overbuilt inventories in the wake of the pandemic's disruption of supply chains.
"For now, labor markets remain tight and wages continue to rise--with anecdotal evidence that some companies are trying to keep workers on through this rough patch in order to avoid the staffing swings that occurred during--and after--the worst of the pandemic," said David Tesher, S&P Global Ratings' head of North America Credit Research. "That said, layoffs are accelerating--especially in tech and finance--and headline unemployment will almost certainly rise from its historic lows, further eroding consumer spending and likely weighing more on corporate earnings."
Macro conditions and recession worries are hitting certain industries disproportionately. Broadly speaking we expect the real estate, technology, media, and health care services sectors to be under the most pressure. This comes as ratings are, on average, lower than they were prior to the pandemic, and debt levels higher, with 12% of U.S. corporates rated 'B-' or below. The net outlook bias, indicating potential ratings trends, widened to negative 8.5% at the end of 2022--a 16-month high (although still roughly half pre-pandemic levels). The corporate sector with the highest net negative outlook bias is consumer products, at negative 21.5%. In the past year, retail, telecom, and high tech have suffered the biggest increase in net outlook bias.
With yields much more restrictive than a year ago and a recession in our base-case assumptions, refinancing risk is higher than in more benign times. In particular, quickly rising rates are adding costs to maintaining floating-rate debt, and any fixed-rate maturities coming due in the near-term will have to be ultimately rolled over at a much higher coupon rate. Through 2024, we estimate speculative-grade firms in the U.S. have $354 billion in debt coming due. Of this, 65% carries floating rates of interest, meaning about $125 billion of fixed-rate debt is about to reset with much higher coupon rates than when it was issued.
At the same time, benchmark borrowing costs look set to go higher, given the Federal Reserve's determination to bring down inflation--with concerns about liquidity growing as the Fed withdraws monetary support at an unprecedented pace. With a historically large number of corporate borrowers in the 'B' rating category and below, sensitivity to this risk is significant.
Still, the maturity wall for nonfinancial corporate debt appears broadly manageable in the near term after many companies pushed out maturities at lower rates. And the buffers that many borrowers built up during the long stretch of favorable financing conditions are supporting credit quality in many sectors. But refinancing pressure is building. Investment-grade debt accounts for 78.8% of total U.S. nonfinancial corporate debt maturing in this year. However, corporate debt coming due rises steadily through 2026, and the share of speculative-grade maturities surpasses that of investment-grade in 2027. Companies tend to refinance their debt 12 to 18 months in advance, and faced with an overhang of pandemic-era debt that begins to mature in 2025, many will be looking for refinancing opportunities.
From a credit standpoint, increases in interest rates and input costs will pressure credit ratios for loan issuers. Accordingly, we expect speculative-grade credit ratings to worsen this year as the effects of tightening financial conditions, high operating costs, and slowing demand hurt profit margins, cash flows, and debt-service capacity. No doubt, the potential transition of 'B-' rated issuers into the 'CCC' range will be a major area of focus for loan investors, including collateralized loan obligations.