With interest rates rising sharply, many weaker companies could come under growing financial pressure, says Moody’s Investors Service.
Last week the U.S. Federal Reserve Board hiked rates by 75 basis points — its largest rate move in years — and signalled that rates will continue to rise sharply this year.
In a new report, Moody’s said that as rates rise, interest expenses “could become untenable” for half the companies it has rated as speculative (B3).
“If rates were to increase 300 bps, many B3-rated companies would be challenged to cover their interest expense, absent meaningful earnings growth,” the report said.
Companies’ free cash flow “would largely evaporate if rates were to rise by 300 bps,” the report said.
For instance, Moody’s noted that in 2021 B3-rated companies produced a combined US$3 billion of free cash flow.
“With a 300 bps increase in rates, aggregate free cash flow plunges to a loss of more than $1 billion,” it said.
Moody’s reported that the “vast majority” of B3-rated companies “are funded mostly with floating-rate debt, making them more vulnerable to base rate increases.”
The report also noted that interest coverage varies by sector, and depends on both rising interest expenses and earnings growth.
So, while the metals and mining sector currently has the strongest interest coverage, Moody’s expects it to face weaker earnings alongside rising interest costs.
Conversely, the hospitality sector had “extremely weak interest coverage in 2021,” it noted, “but we expect a strong rebound in earnings.”