Maturity Monday

Topics: Corporate Bonds, Maturity, Refinancings

Howdy team! Welcome to today's edition of the Stonk Science newsletter :D 

Here's a quick fixed-income joke for you before we jump in:

What do you call a bond with a phone?

A callable bond!

You're welcome hehe

Overview

Companies have been getting turnt on cheap debt, aggressive amounts of market liquidity, and v inflated consumer spending throughout the second half of 2020, all of 2021, and the first bit of 2022. Then, the Fed rolled up and says "party's over" and all the investors said "peace ✌️". Who would've guessed that the infinite QE party would end!?

For context, here are corporate bond issuances since 2017:

2020 and 2021 had larger issues due to lower interest rates (obvi), while 2022 was abysmal in terms of new issuances because of spiking interest rates. The pretty chart below proves my point:

These high rates, in the grand scheme of things, are still pretty new and most companies front-loaded debt issuances (plus some) to take advantage of low rates back in 2021 and early 2022, so they haven't dealt significantly with the higher borrowing costs. As discussed in a previous article, it takes 12-24 months for the full effect of interest rates to be realized in an economy - this is one of the reasons why. Companies will realize the full weight of higher interest rates once they issue new debt or refinance existing debt under current market terms; fixed-rate debt will be impacted the most, as floating-rate debt has already become more expensive due to higher floating rates (wider credit spreads will make floating-rate debt more expensive upon refinancing). 

What I'm curious about is (1) when companies will take out more debt and (2) at what interest rates they'll borrow at. 

Let's get into it!

Just How Levered Are You?

It's should be no surprise that we are at the peak of a debt cycle (for more context on debt cycles, plz watch this video), but just how soon will companies have to face their debt balances?

Well... I looked through ~150,000 debt securities to find you the answer (just for companies in the S&P 500). You're welcome in advance - my computer crashed several times running my excel and python scripts lol. Here's the number of bonds maturing over the foreseeable future (not including commercial paper):

*This includes a variety of debt instruments including corporate bonds, notes (fixed and floating), mortgages, debentures, and some preferred and complex securities - this excludes commercial paper).

There are, evidently, a lot of impending maturities, but the number is a bit misleading. Sure, about 31% of outstanding bonds are maturing in 2023, but they only represent 4.5% of the dollar amount outstanding. 

There's almost $2.5T of debt maturity that will come due over the next two years, though it is minimal in relation to the amount of debt that matures during or after 2032. 

Something else to consider: the interest rates and YTM of bonds are closely following the current yield curve during the short-term, but not the long-term. We can use the coupon rate vs YTM as a proxy to hypothesize that many of the issuances done during 2021 were long-term issuances (the coupon payment being below the YTM of the same maturity indicates that companies currently have debt that is cheaper than the current market price). 

At What Cost?

It's somewhere between tough and impossible to forecast future interest rates, though it largely depends on the terminal fed funds rate and the impending recession (it's still happening, right? haha). In lieu of a magic ball, we can evaluate the Federal Reserve (board meeting on Wednesday JSYK), the current yield curve, and current credit spreads. 

1) The Fed is contracting its balance sheet and is expected to slow its pace of interest rate increases (and may even pause them in their entirety); both of these will likely increase treasury yields, which will put upward pressure on corporate bond yields. The focus of investors, however, has been on the terminal Fed Funds rate and if/when the Fed will "pivot" and cut rates. 

2) The current yield curve is still deeply inverted. While an inverted yield curve typically signals a recession, this could signal the market's anticipation of the Federal Reserve pivoting and cutting interest rates. 

3) Credit spreads are elevated relative to the post-pandemic era, but are nominally in line with historical levels (despite the aggressive amount of volatility). Future credit spreads will likely be determined by the probability of a recession and how deep a recession would be if it occurs. Considering the high probability of a recession, it appears like the market's discounting the severity of a deep recession in favor of a soft landing. 

I really like having a grip on the direction of interest rates, but I think this is a really big question market for many. Frankly, there are a lot of variables going into this, so it'd be extremely hard even for experts to forecast. Some of the things we need to account for include: The Fed's short-term and long-term interest rate policy, how quickly the Fed wants to unwind its balance sheet, the probability of a recession, the severity of a potential recession, how investors will perceive news pertaining to the Fed and a recession, as well as general market news regarding consumer spending, mass layoffs, growing consumer debt balances, etc... 

All those uncertainties give off "up and to the right" vibes, but there are too many unknowns that depends on too many other people to accurately forecast. It is true, however, that companies that refinance in the current interest rate environment will face higher borrowing costs than what they're used to.

Overview

Companies took out more debt than usual while interest rates were extremely low and extended their maturities further into the future. While many companies will be only slightly impacted by higher borrowing rates, companies with large amounts of debt maturing in the next year or two will be the most impacted by these borrowing costs. Despite many stocks trading at a steep discount, I'd be careful before investing in companies that have a maturity wall, as it could quickly turn into a ticking time bomb (refer to BBBY, Toys R Us, etc... for historical reference).

In Summary

• Companies took out a lot of cheap debt during 2021 and extended their average debt maturity further into the future.

• Companies in the S&P500 have over 40,000 debt instruments maturing throughout 2023, though they represent only a small fraction of the total amount of debt outstanding.

• Many entities took out long-term debt when rates were cheap, as evidenced by many instruments trading at a premium.

• Interest rates have been volatile since 2021 and I don't expect that to change given the potential impacts of a Fed pivot and a recession.

• Plz do extra analysis before investing in companies with a debt maturity wall, as it could quickly turn into a ticking time bomb should they be unable to pay.