Record borrowing costs were not enough to prevent a decline in the ability of US companies to service their debts in the first half of 2020.
The median interest coverage ratio for U.S. companies rated investment grade by S&P Global Ratings fell to 5.48 in the second quarter, from 5.65 in the first quarter and 6.32 at the end of 2019. lower quality, the ratio – calculated by dividing earnings before interest and tax, or EBIT, by the cost of its debt interest payments – was 2.6 in the second quarter, down from 2.4 in the first quarter, but down from 2.8 in the fourth quarter of 2019.
The decline in ratios reflects a slump in earnings as the coronavirus pandemic ravaged the US economy: Average earnings per share across the S&P 500 fell 33.3% year-over-year in second trimester. The relatively small decline in interest coverage ratios is due to the Federal Reserve cutting its benchmark rate from 1.5%-1.75% to 0.0%-0.25% in March.
That helped drive the average cost of borrowing for high-quality U.S. companies to a record low in June after peaking at the start of the pandemic. The yield to maturity on the S&P 500 Investment Grade Corporate Bond Index, which was at 2.10% in early March, rose to 4.20% later in the month. It has since fallen to 1.74% in August and was at 1.95% on October 5.
“In [the first half of] 2020, these interest coverage ratios have declined even though the Fed [funds rate] was going to get closer to zero,” Evan Gunter, head of S&P Global Ratings, said in an interview. “What we’re primarily looking for is economic growth to rebound and incomes to pick up.”
Some sectors have been hit harder than others. Investment-grade consumer discretionary companies were among the best-positioned sectors before the pandemic with an interest coverage ratio of 11.2 in the fourth quarter of 2019. Successive declines of 25% in the first quarter and 34% in the second quarter resulted in the ratio being halved to 5.6.
The consumer discretionary sector, which includes hotels, retailers and restaurants, has been particularly hard hit by the pandemic. The sector leads the number of bankruptcies among major US companies this year. Of the 509 bankruptcies tracked by S&P Global Market Intelligence through October 4, 102, or 20%, were from the consumer discretionary sector.
The energy sector also performed poorly by this metric. Its interest coverage ratio, at 4.58 among investment grade companies, was already among the lowest heading into the pandemic. By the end of the second quarter, it had fallen to 2.42, meaning almost half of his companies’ profits were spent on servicing debt.
Energy companies accounted for 11.6% of U.S. bankruptcies tracked by S&P Global Market Intelligence this year, third after industrials.
Among the sectors with stable or improving interest coverage ratios this year are health care, which rose from 8.44 to 9.84, consumer staples, which rose from 7.89 to 8.50, and information technology, which went from 11.76 to 10.01.
The sector with the lowest interest coverage ratio in the second quarter was real estate at 1.96, but this is only slightly below its historical average of just over 2. Real estate is a business highly leveraged, but revenue streams are generally stable as landlords work with 5, 7 and 10 year lease structures, helping them through the economic disruption. Utilities have a similarly low ratio, 2.49 for quality investments and 1.81 for non-investments, but like real estate they have a reliable stream of income, with bills usually being the last expense to be incurred. be reduced by households.
Financials benefit from the highest ratio, at 10.42, little changed from its historical average.
Falling interest coverage ratios have contributed to a decline in solvency, a particular concern for companies rated just above investment grade.
Overall there have been 41 fallen angels — companies that have been downgraded from investment grade to non-investment grade — so far in 2020, including 19 in the US, while S&P Global Ratings downgraded just 22 companies in total in 2019. S&P noted in a recent report that the final 2020 total is on course to break the 2009 record of 57 fallen angels worldwide.
The downgrades in the US mean that a total of $252 billion in rated debt has fallen into the high yield segment.
However, the worst may already be over for companies on the verge of a so-called junk rating.
There was just one addition to the Fallen Angels in August, the lowest since April, while five companies were removed from the list of potential Fallen Angels between July and August.
Of the companies S&P has listed as potential fallen angels, the proportion considered to be at immediate downgrade risk fell to 11% in August from 13% in July, and is considerably below the five-year high of 27% in April. .
“The Fed’s policies have certainly helped to ensure that there is enough liquidity to prevent investors from becoming overly concerned about the balance sheets of long-term viable companies,” global head Anik Sen said via email. shares in PineBridge Investments.
“Investors are still concerned about the balance sheets of leveraged companies that are heavily impacted by the pandemic, especially those that had weak business models before the pandemic. Bankruptcies and credit downgrades are still happening for these types of companies. ‘companies’, Sen wrote.