Leveraged U.S. Corporates May Face Challenges from Rising Rates

Rising interest rates may translate into downside risk for some U.S. corporate sectors. The credit profiles of U.S. corporates are generally insulated from rising rates, but lower-rated issuers are more vulnerable, according to a new report from Fitch Ratings.

The ratings agency does not see significant interest rate risk across speculative-grade credit profiles, even in a severe stress scenario, but a rising rate environment may limit the margin of error available to corporates that are undergoing material acquisition or in the midst of adjusting their business models. This is particularly true for those that are highly leveraged. Poor execution of cost-saving programs and key initiatives, for example, may hamper a cash flow profile that is already weak if coupled with rising rates. Negative rating actions may result.

The retail sector, with high floating-rate debt exposure, is vulnerable to interest rate risk if the benefits of a growing economy are offset by secular challenges, Fitch said. Diversified manufacturing, which likewise has high floating-rate exposure, could see improved demand, though external factors such as an increase in trade restrictions could weigh on costs and hamper growth. Sectors with low floating-rate exposure like telecom face their own challenges from a competitive environment.

The stable outlook for U.S. corporates for this year supports the view that rates rise in response to increasing inflation during an economic recovery, Fitch said. Since companies have been proactively managing maturity profiles, modest rate increases, without an increase in spreads, would not impact interest rate expense in the near term. Investment-grade corporates are less vulnerable to rising rates. Fitch estimates that its portfolio of speculative-grade corporates has an average of 52% of floating-rate debt compared to 15% for investment grade.

– Adam Fusco, associate editor

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