NEW YORK: Many US companies that gorged on cheap debt with forgiving terms over the last decade now find themselves shackled by it, spending much of their earnings paying off lenders rather than investing in their businesses or hiring.
As small firms, which together account for half of US employment, begin to feel the squeeze, this could have a chilling effect on hiring, wages and consumption, adding to headwinds from wobbly financial markets and ebbing global growth, economists and corporate finance professionals say.
The number of companies struggling with their debt obligations is hovering near record highs. Some 17 per cent of publicly-traded US companies had trouble making debt interest payments at the end of last year, up from less than 10pc in 2010 and off from a high of over 20pc in 2016, according to the Institute of International Finance Inc, a trade group for financial institutions.
In value terms, such firms account for a fraction of companies the IIF monitors. But they exemplify the struggles of a bigger universe of private firms which have loaded up on so-called leveraged debt, typically variable-rate loans offered on generous terms by banks and non-bank lenders. With Federal Reserve rate increases pushing up interest expenses and the US economy facing a slowdown as it nears a cyclical downturn, more and more of those borrowers may scramble just to stay afloat.
“It could reduce capital expenditures, capital deployment and lock up the economy, because companies could be so focused on making debt payments that they may not be hiring,” said Christopher Zook, chief investment officer of family office CAZ Investments LLC.
Take CPI Card Group Inc, which makes credit and debit cards for banks and retailers. The card maker was among firms that tapped the leveraged loan market, when it borrowed $435 million for general purposes before it went public in 2015.
CPI repaid some of the loan with proceeds from its public offering, but as its profits have deteriorated, the company has nearly lost its ability to service the remaining debt. Its earnings for 2018 roughly matched its debt expenses, according to Moody’s Investors Service, down from nearly five times the size in 2014.
The company cut its headcount by 13pc between 2015 and 2017 to 1,200 workers. Last year, it shut a plant in Littleton, Colorado, where it is headquartered, according to the state’s Department of Labour and Employment.
As Americans complete the shift to chip-enabled credit cards, CPI forecasts revenue will rise in 2019. But the forces that have held it back will persist: the credit card maker is losing market share to competitors, and high inventories help big banks keep prices low, says Stephen Morrison, analyst at Moody’s. CPI Card declined to comment.
Investors’ hunt for higher returns in an era of record-low interest rates has given debt-laden companies access to cheap, easy credit, encouraging them to take on more debt than would be possible in less forgiving conditions.
As a result, the median debt levels of non-financial companies relative to their earnings already exceed levels before the last financial crisis, according to Standard & Poor’s rating agency. While US policymakers assure that credit conditions remain broadly healthy, the volume of leveraged loans, which are rated as junk or near junk, has doubled to a record $1.4 trillion over the last five years.
Published in Dawn, February 6th, 2019