Companies that piled on debt throughout the pandemic and the economic recovery could be in for a tough road ahead as the bills come due.
Corporate borrowers will have to pay more of that debt back as refinancing grows more difficult with rising interest rates. The persistent squeeze from inflation is keeping costs high for many companies while stifling consumer demand and sapping purchasing power.
Corporate debt rose from roughly $16.3 trillion just before the pandemic hit to about $19.8 trillion near the end of 2022, according to the Federal Reserve. Economists and analysts expect some kind of recession to hit the U.S. economy in 2023 and the severity of it could weigh heavily on both large and small companies as they repay debt.
"Near-term profit pressures on U.S. corporate borrowers look set to intensify," noted a report from S&P Global Ratings on the outlook for corporate credit.
The report shows that corporate debt coming due steadily rises through 2026, with speculative-grade debt surpassing investment-grade debt in 2027. Speculative-grade debt carries a higher risk of default than investment-grade.
"Faced with an overhang of pandemic-era debt that begins to mature in 2025, companies will be looking for refinancing opportunities," S&P Global Ratings said.
Refinancing risks are increasing partly because of the potential for a recession. Credit rating trends are already turning negative, with more downgrades than upgrades on debt since August. It all adds up to default risks rising as companies get pinched by a weakening economy and have a difficult time refinancing existing debt.
The Federal Reserve has sharply raised its benchmark interest rate in an effort to tame inflation, but that has made borrowing more expensive. The rate is currently in a range of 4.50% to 4.75% after starting last year at basically zero. The widespread expectation is now for the Fed to increase the rate to at least 5.25% by June and some bets on Wall Street are calling for a rate of up to 5.50%.
The tougher financing atmosphere is running up against an economic slowdown. Google's parent company Alphabet, Dell and other big technology companies have been cutting staff in an effort to control costs as demand wanes. Retailers, including Walmart and Home Depot, have been issuing warnings about weaker consumer spending.
"Many companies will find it more difficult to balance still-elevated input costs and waning demand amid the prospects of a downturn in the world's largest economy," S&P Global Ratings said.
The broader labor market has remained relatively strong, but a downturn in employment could further weaken consumer spending and hit corporate earnings. Companies in the S&P 500 reported a broad 4.6% contraction in earnings during the fourth quarter of 2022 and analysts expect similar results during the first half of 2023.