UBS: The Sensitivity of Corporate Credit to Higher Rates

The critical questions

Many clients are concerned about the impact of higher rates sensitivity on corporate credit, particularly after today's Fed rate hike. But other investors believe debt burdens are sustainable given low rates, fixed rate exposure, and a rebound in 2017 earnings. We set out to address these market views in a macro and micro fashion.

Floating-rate exposure still matters, particularly for smaller, low-quality firms

We gauge the fixed vs. floating-rate nature of the credit market by analysing traded credit markets and bank C&I loans. The current breakdown of corporate credit is roughly 2/3 fixed and 1/3 floating. This split is not materially different than during past cycles. Much of the floating exposure is centered on speculative-grade markets. We find that 65% of below investment-grade firms have floating rate exposure, when we add in lower-quality bank C&I loans. In addition, while high grade issuers have extended average bond maturities significantly post-crisis, the average life for high yield and leveraged loans has seen little to no shift.

Interest coverage ratios at a macro level are poor and set to worsen

We calculate that gross corporate interest payments to GDP are near cyclical peaks. Material corporate issuance alongside weak growth has started to overwhelm the impact of low rates. We run future scenarios out to 2018 for interest coverage and conclude that coverage metrics are set to see moderate to substantial weakening. This will remain a structural problem for markets. Interest payments to GDP cannot be normalized absent a reduction in debt growth with rates still low. The best scenario would involve changes in capital structures to favour equity over debt.

Stronger revenue growth and stable margins are essential to supress this risk

A strong positive is that interest payments relative to profits are less alarming due to resilient profit margins. And expected 2017 earnings growth coupled with stable margins should help interest coverage. But it is critical that this playbook come to fruition. In the context of a Fed rate hike cycle, future earning misses will no longer just expose high leverage, but also weakening interest coverage. We believe the canaries in the coal-mine will come from lower-quality spec-grade firms exposed to floating-rate risks and near-term maturities. We express a clear preference for high-quality floatingrate leveraged loans over US HY, given a lower beta to volatility and duration than US high yield and higher recovery rates due to their senior position in the capital structure.

Die komplette Marktanalyse ald pdf-Dokument.