Re-finance before the rush?

Dec 15th 2016 |

Debt is cheap now but for how long? After only the second interest rate rise in a decade, the Fed predicts three more rate hikes in 2017. And there are more reasons than just monetary policy to make companies think hard about bringing forward financing plans.

US rate rises

This week's rate rise of 25bps from 0.5%-0.75% was priced in by the markets and reflects strong US GDP growth. The latest figures show the economy growing at an annual pace of 3.2% in the third quarter, up from 1.4% in the quarter to June. This has pushed the headline jobless rate to 4.6%, below what policymakers believe is the "natural rate" of unemployment.

But it's what happens next that makes the real difference. If president-elect Trump's plans for fiscal stimulus and infrastructure spending materialise in full, GDP growth will be stronger still and already there are forecasts of four rate hikes next year rather than three. However, Trump's plans also include elements of protectionism which, if implemented, will be negative for growth. How those tensions play out will partly determine the path of US rates in the next months and years.

Europe in crisis?

And then there is Europe. A full-blown banking or sovereign debt crisis there would slow US rate rises and in both Italy and Greece, old problems have still not been addressed. Italy's third-largest bank by assets, Banca Monte dei Paschi di Siena (BMPS), announced this week that the European Central Bank rejected its request to extend a euro5 billion capital increase from December 31 into January. The ECB stated that it was worried the Italian lender’s liquidity and capital ratios may deteriorate, posing a risk to its survival.

Italy is still reacting to the resignation of reformist prime minister Matteo Renzi and the political situation can only be made more difficult by the likely state bailout of BMPS. To meet EU rules, state aid would require haircuts from bondholders, many of whom are retail investors.

Meanwhile in Greece, the European Stability Mechanism's board of directors decided on Wednesday to freeze a deal regarding short-term measures to lighten Greece's debt load until a fiscal assessment of handouts to struggling pensioners announced last week by Greek Prime Minister Alexis Tsipras has been carried out.

Political risks will only increase next year with elections in four of the euro zone's five biggest economies, including France and Germany. And the long-simmering problems in China remain.

The refinancing wall

It's not just interest rate forecasts that should sway treasurers. Supply and demand in the capital markets, especially as banks have reined in cross-border lending, are key variables.

First, there is the redemption schedule. According to Thompson Reuters, around USD3 trillion-worth of loans and bonds (excluding financial and real-estate companies) a year will need re-financing each year from 2017 to 2020. But almost two-thirds of that is bank debt. If banks' appetite for assets does not improve, a proportion of this will need to be supplied by the bond markets - at a time when rates are rising.

In the US, the re-financing situation may be trickier still. Over the past decade corporate debt has risen by 75% to USD8.4 trillion according to the Securities Industry and Financial Markets Association (USD11.3 trillion if you include commercial paper). The debt binge has pulled down credit ratings and pushed debt to EBITDA ratios to levels not seen for more than a decade.

A lot of this debt is coming due in the next four years. Data from S&P shows redemptions of bonds, loans and revolving credits at around USD600 billion for 2016 rising annually to 2020's figure of USD1.05 trillion. A third of this was issued by non-investment grade companies who may find it harder to sell their stories in a higher-rate environment.

These developed market borrowers will also be competing for investor interest with emerging market issuers for scarcer investor dollars. The amount of US-dollar bonds issued by companies in emerging countries almost tripled to $34.7 billion in September from the month before, according to research firm CreditSights. Much of that debt - 70% of which was for Asian issuers - is being used to re-finance existing liabilities and corporate leverage accounts for around half of Asia’s debt to gross domestic product. In China, corporate debt is equivalent to 120% of GDP.

In summary...

Right now, it may seem as though there is little need to panic. Corporate bond spreads have not been as volatile as sovereign in the wake of the Trump election and top names have been able to get large issues away (Pfizer's $6 billion in mid-November for example). However, the average yield on Moody's Baa index is now at 4.9%, the highest since March. Better to be too early than too late.