Is Your Credit Portfolio Ready for the Next Interest Rate Hike?

The Fed sees signs of economic strength, and is now more likely to raise interest rates, says Federal Reserve Chair Janet Yellen in August of 2016

Recently, the Fed signaled that rates may go up before the end of the year.

Recent economic indicators have been mixed -- monthly jobs, automotive sales, the ISM Manufacturing Index, and the NACM Credit Managers Index, to name a few --  but there are enough signs of economic health to make this a real possibility before year-end.

The Fed sees signs of economic strength, and is now more likely to raise interest rates, says Federal Reserve Chair Janet Yellen in August of 2016

Whether a rate hike comes in September or December, higher interest rates will have a real impact on your credit customers.

If your customers need to refinance at higher rates, will they be able to?

Corporate Debt More Than Double the 2008 Level

In aggregate, the debt load for large companies has more than doubled since 2008, due to artificially low interest rates over the last 7 years. This is a large contributor to increasing defaults and bankruptcy risk. In the long term, this level of debt is not sustainable.

  • According to S&P Global Market Intelligence, “... the global corporate default tally is 54% higher than it was at this time last year, and has surpassed the total number of defaults in 2015.” Two thirds of these global defaults are from the U.S., and downgrades continue to outpace upgrades.The last time the tally was higher at this point in the year was in 2009, during the Great Recession.
  • In September, the FRISK® Stress Index is 67% higher than it was before the last financial crisis, showing the increase in aggregate financial risk for U.S. public companies since the last financial crisis.
Financial risk for U.S. Corporations, according to the FRISK® Stress Index as of September 2016, a measure of aggregate public company bankruptcy risk

Drowning in Debt vs. Financial Health

For most financially resilient companies, a long-expected interest rate hike will not present an immediate burden. Interest rates are still extremely low, by historical standards.

However, the increase in risk for highly leveraged companies is another matter, as higher borrowing costs make it harder to generate cash to cover interest obligations as well as operations. For these companies, it’s important to pay extra attention to refinancing needs.

An interest rate hike can also cause the economic recovery to stumble, and create greater risk in industries where weak global demand and other factors have already increased risk. This is particularly true in distressed industries like commodities and energy, retail, and shipping, where many industry participants are already drowning in debt.  

For instance, the global speculative-grade default rate for the energy and natural resources sector was 17.2%, more than 7x higher than the default rate of other sectors, according to S&P (August, 2016).

What a Fed Rate Hike Means for Credit

So, should you be concerned about a rate hike?

It depends on your credit portfolio. While it’s not a game changer for customers with a solid financial condition, it signals tougher credit decisions to come for your higher risk counterparties.

To put portfolio risk in context: for some of our clients, up to a quarter of their portfolio companies have a FRISK® score in the red zone, with higher than average financial stress and bankruptcy risk. 

As you assess your portfolio risk, pay particular attention to what a rate hike will mean to these highly leveraged or below investment grade public companies, before the Fed begins a gradual tightening.

Watch those companies like a hawk.

Be proactive to mitigate interest rate risk!

Canadian hockey legend Wayne Gretzky once said. “A good hockey player plays where the puck is—a great hockey player plays where the puck is going to be.”

It's the same with business credit analysis. If you keep an eye on the horizon, you'll never be surprised.

Need help assessing the financial health of your credit portfolio or supply chain? Use the FRISK® score for advance warning of increasing risk, and get in touch if we can help with a personalized portfolio review.

Get help identifying your risk exposure: Contact us for a personalized portfolio review

About CreditRiskMonitor

CreditRiskMonitor is a financial news and analysis service designed to help professionals stay ahead of public company risk quickly, accurately and cost-effectively. More than 35% of the Fortune 1000, plus thousands more worldwide, rely on our commercial credit reporting and predictive risk analytics for assessing the financial stability of more than 56,000 global public companies.

At the core of CreditRiskMonitor’s service is its 96%-accurate FRISK® score, which is formulated to predict public company bankruptcy risk. One of four key components calculated in the FRISK® score is crowdsourced subscriber activity. This unique system tracks subscribers' patterns of research activity, capturing and aggregating the real-time concerns of what are essentially the key gatekeepers of corporate credit. Other features of CreditRiskMonitor’s service include timely news alerts, the Altman Z”-Score, agency ratings, financial ratios and trends. CreditRiskMonitor’s network of trade contributors provides more than $150 billion in trade data on their counterparties every month, giving them visibility into their biggest dollar risks.