Quiet on Wall Street. too quiet Fall is often one of the busiest times of the year in the financial world, but in recent weeks sales of new shares, debt raisings and corporate mergers have reduced to a trickle. The supply of cash that powers such deals is evaporating, and the slowdown is likely here to stay, bankers, investors and corporate lawyers say.
The markets are stuck because the price of borrowed money is rising, following the interest rate hikes by the US Federal Reserve in its war against inflation.
That policy has yet to reduce consumer spending, but it is punishing American companies that have collectively amassed more than $10 trillion in debt, most of it over the past decade, when the Fed kept interest rates close to zero.
North American companies will need to raise at least $200 billion in 2022 and 2023 to cover interest expenses, according to a Wall Street Journal analysis of data from Fitch on the companies it rates.
Borrowing costs could remain high for years if high inflation continues, and they will split American corporations into two camps: those that can cut debt and survive on their profits alone, and those that cannot.
The main thing corporate clients want to talk about is the Fed, says Stefan Feldgoes, co-chairman of the mergers and acquisitions team at Goldman Sachs. “Given the significant changes, we spend a lot of time simply talking about what’s happening and how it affects.”
Ford: “We were unable to roll over the loan costs”
The market value of a company Ford reaches 53 billion dollars and last week it reported an improvement in sales. Still, “borrowing costs were higher, and we weren’t able to fully pass them on to customers,” Marion Harris, director of Ford’s lending arm, told analysts. The lending department cut its 2022 profit forecast by 10%, partly because of high interest rates.
Hospital chain Community Health Systems bought back $267 million in bonds recently, but its profits are falling faster than it can reduce $12 billion in debt. “Increases in contractor wages and salary inflation continue to affect our performance,” said the company’s CFO, Kevin Hammons, in a call about the company’s results last month.
The company’s bonds have fallen about 35% since September, to 42 cents on the dollar, reflecting uncertainty about its financial health.
Some companies profit from the mess. Apollo Global Management spent more than $1 billion in October buying investment-grade asset-backed debt, and sold it during market turmoil, said partner John Zito. That came after $6 billion in purchases in the third quarter, including investment-grade bonds and junk-rated insured loans from companies such as Royal Caribbean Group, Carnival Corp and Citrix Systems.
Much of this debt is yielding more than 10%, and even investments that continue to decline in price should yield long-term returns, Zito said.
Interest rate hikes are suffocating companies that depend on cheap debt
Aggressive interest rate hikes are stifling industries that depend on cheap debt to grow, such as real estate and finance. The Fed hopes that the slowdown will eventually spread to the real economy, with less employment and less corporate spending hurting the budgets of households, which are already experiencing a sharp drop in home values.
Mergers and acquisitions in the US reached a total of $219 billion in September and October, down about 43% from the same period last year, according to data from Dealogic. Equity issuances fell to $1.6 billion in October, down 95% from a year earlier First, and the lowest volume since 2011. The decrease in the volume of transactions means a decrease in commissions for investment banks.
Funding of investment instruments known as CLOs, or collateralized loan obligations, fell 97% from last year’s levels to $1.3 billion, partly because of the consequences of the financial crisis in Great Britain. CLOs are the biggest buyers of junk-rated debt, which private equity firms use to buy target companies, and the flow of those loans fell about 70% to $54 billion in October.
Banks that agreed a few months ago to sell investment managers loan funds for leveraged purchases at a lower interest rate, were forced to hold up to $45 billion of the debt, because investors are now demanding much higher returns. Debt prices fall when interest rates rise, and the banks have to finance the loans, recording losses on paper of billions of dollars. Bankers and private equity firms have moved from easy financing of purchases at high prices to a struggle to raise debt at any cost.
“I’m most worried about what will happen to the high-rated investments made in the last two years,” said Andrea Auerbach, global director of private equity at consulting firm Cambridge Associates.
Enjoy Technologies, an online store led by Ron Johnson, former Apple sales executive, went public in October 2021 through a merger with a SPAC. The company had planned to finance itself by raising capital, but in May disclosed that it was having trouble finding investors and filed for bankruptcy protection in June.
Or for example Citrix Systems, the cloud computing company that private equity companies bought, among other things with the help of borrowed money, for $16.5 billion in September. Banks suffered losses of at least $500 million after having trouble selling the loans. Citrix is already on Fitch’s list of highest-risk borrowers.
The list of leveraged deals that lost money grows and weighs on the balance sheets of the banks, including $13 billion backing the purchase of Twitter by Elon Musk, $6 billion on Apollo’s purchase of auto parts maker Tenneco, and about $8 billion from private companies’ takeover of the communications company Nielsen Holdings.
Not all banks are stuck with unwanted debt
There are private equity deals that are progressing, and not all banks are stuck with unwanted debt. Blackstone revealed last week a $14 billion purchase of a climate technology company. At JP Morgan Chase, they avoided most of the problematic financing this year. But M&A activity is entering a hibernation that could last until the summer of 2023 or beyond, said lawyers who work on such deals.
The pain on Wall Street also echoed in the rest of the country. Private equity companies did about a trillion dollars in transactions last year, and also entered niche industries, such as car washing, and the price of loans taken by these companies rose in coordination with the increase in interest rates.
As private equity funds become less profitable, it hurts US pension funds, which rely more and more on this asset class, and face big losses in the bond and stock markets of public companies.
If the cracks weakening the financial markets spread to the rest of the economy, a continuous cycle of defaults could follow.
“We believe there is a good probability that there will be 2,000 credit rating downgrades and 200 issuer defaults in the 2023-2024 credit cycle,” said Marathon Asset Management CEO Bruce Richards. The number of defaults will likely be greater than credit crises. Earlier, because inflation would prevent the Fed from lowering interest rates to ease economic suffering, as it did in 2009 and 2020, he said.
Past-due payments on junk-rated debt are already rising in price, and that debt could reach half a trillion dollars — well above the $200 billion that was the debt’s peak in 2008 and 2009 — because there is so much more debt hanging in the air now, said the Marathon.
“We are bullish on the opportunities that the 2023 debt cycle could offer,” Richards wrote. “We believe winter is coming.”
Laura Cooper and Hannah Meow participated in the preparation of this article