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Major US companies exercise caution when it comes to the timing of their bond sales, adhering to a general rule.
In the years following the financial crisis, investment-grade companies would halt bond sales during periods of rising Treasury yields and resume them when yields fell. It was a relatively straightforward approach.
However, the current scenario raises questions. Despite 10-year Treasury yields climbing to 4.2%, nearing 15-year highs, companies continue to issue a substantial amount of investment-grade debt.
This suggests that companies do not anticipate a quick decline in yields. Bank of America’s credit strategists have emphasized this point in their recent note. Their rates team predicts that the 10-year yield will hover around 4% by the end of this year, and 3.5% by the end of 2024, remaining at those levels until the end of 2025.
On one hand, this indicates that a significant recession, which would compel the Federal Reserve to reduce rates next year, is unlikely — a positive development. However, it could test the ability of corporate borrowers to handle higher rates in the long term.
In a previous note, BofA examined the historical correlation between US rates and interest coverage ratios, which divide a company’s earnings before interest and taxes by its interest expense. They found that there is typically a lag of around two years between a rate hike and a decline in companies’ interest coverage.
A prolonged increase in the US policy rate may negatively impact the interest coverage ratio of investment-grade corporate market. Based on historical trends, the coverage ratio tends to follow interest rates with a delay of approximately two years. This stands to reason as interest rates are more volatile than debt levels, and it takes time for previous debt to be replaced. According to this historical relationship, the current 10-year Treasury yield of about 4% implies an interest coverage ratio of approximately 10x in 2025, down from 11.9x in Q1 2023. This would be among the 13th percentile since 2010 when rates were relatively low, but ranks 37th percentile for the period since Q1 1997.
However, this analysis is based on historical data. If borrowing costs for investment-grade companies continue to remain at current levels (with the index yielding 5.5%) over the next two years, their ability to cover interest costs could decline to its lowest point since 2003, as per BofA’s findings.
Assuming debt and earnings remain static, we estimate that rolling over maturing debt at the current
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