According to BofA Global, the ability of big U.S. companies to pay interest on their debt may reach its lowest point in two decades if the Federal Reserve decides to maintain higher interest rates for an extended period of time.
During the pandemic, major corporations, like homeowners, took advantage of low policy rates set by the Fed to borrow extensively, aiming to mitigate the potential economic crisis.
This borrowing frenzy provided insulation for many large corporations and households, shielding them from the impact of subsequent rate hikes implemented by the Fed since March 2022. This was primarily due to the fixed and lower cost attached to their existing debt.
However, if the central bank persists in maintaining high policy rates as part of its efforts to combat inflation, it risks severely hindering corporations’ ability to meet their interest payment obligations. In fact, these levels could be among the lowest seen since 2003, as highlighted in BofA Global’s analysis.
The analysis conducted by BofA Global strategists focuses on estimated interest coverage ratios for corporations with investment-grade credit ratings, assuming that the Fed will continue to keep its policy rate elevated until the end of 2025.
A higher coverage ratio indicates that companies will face less difficulty in paying interest on their outstanding debt.
The analysis further assumes that debt maturing over time will carry the current 5.5% yields of the ICE US Corporate Index. Based on these assumptions, the coverage ratio is projected to decline from 11.9x in the first quarter of this year to 8.7x by the end of 2025. The analysis assumes no changes in debt or earnings.
It is evident that big U.S. companies are likely to encounter challenges in meeting their debt interest payments if the Federal Reserve maintains higher interest rates for an extended period as part of its ongoing efforts to address inflation concerns.
