Rising funding costs for high-yield refinancings, if they persist, could lead to downgrades and defaults for the weakest speculative grade issuers, rated B-* and below, according to Fitch Ratings. Stronger high-yield names should be able to cope with the additional costs.
The findings come from a stress test of Fitch’s portfolio of around 300 private credit opinions on leveraged loans (denoted by a * rating suffix). It modelled what would happen when legacy debts, borrowed cheaply in 2006-2007, are refinanced at higher rates.
For B* category credits Fitch increased median borrowing costs to 750bps from 600bps. The stress was higher for B-* credits, with costs rising by 260bps. This stress doesn’t take it as far as some of the more extreme all-in costs, but rather reflects Fitch’s experience of increases in predominantly bank financed deal costs over the past two years.
Under this stress, interest cover for B-* names falls from 2.3x to 1.7x, a level at which these companies may struggle to attract lenders to participate in a refinancing. They will also have every incentive to put off refinancing as long as possible, potentially increasing their vulnerability to market sentiment when debts fall due.
The roughly 50% of the portfolio rated B* and above has a lot more resilience. These credits are typically larger borrowers with incumbent status in their industries and with international reach, allowing them to benefit from global growth. They also on average have lower debt loads than B-* companies. They can generate sufficient cash flow to cope with higher funding costs, and, under the stress applied, generally escape negative rating actions.
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