Debt ratio down 34 percentage points from pandemic peak

Despite weak second-quarter profits and two and a half years of negative operating cash flow, Norwegian Cruise Lines executives forecast tailwinds for 2023. An increase in cruise bookings next year and higher prices” rebuild and improve margins” and maximize cash flow generation, the company told analysts during its October 6 Investor Day.

To help improve its balance sheet, Norwegian, like other heavily indebted companies, plans to pay down some of its $12.2 billion long-term debt. Over the next two to three years, approximately $1 billion per will mature.

But the company’s board avoids “issuing any kind of stock to repay debt or get out of debt”, Norwegian CFO Mark Kempa told Yahoo Finance Live October 6.

Instead, the debt will be repaid “in the normal course of business through good old-fashioned earnings and cash generation,” Kempa said.

A broader look at data from S&P Global Market Intelligence out of about 8,000 U.S. companies rated by S&P Global suggests many have already lost cash reserves to service debt in the second quarter, lowering leverage ratios below pre-pandemic levels.

The median debt-to-equity ratio – calculated as total liabilities as a percentage of equity – for non-investment grade issuers fell to 88.6% in the second quarter and has been declining since the first quarter of 2020. dropped to 123.4% (see chart).

Companies “got into debt to bolster their cash reserves” during the worst of COVID-19 and are now reducing inventory, S&P analysts say. The movement in the second quarter of corporate cash ratios – calculated by dividing cash and cash equivalents holdings by current liabilities – supports this conclusion.

“[Issuers] would “prefer to pay down debt rather than refinance at higher borrowing costs,” according to the S&P report.

Indeed, with spreads widening and returns of around -18% since the start of the year for some bond investors, only $295 billion in corporate debt was issued in the third quarter, according to SIFMA, down 33% from 2021.

Debt Payment Coverage

But lower debt ratios are not everything.

The interest coverage ratio for S&P-rated companies — a measure of the issuer’s ability to cover interest payments with earnings — was also healthier than pre-pandemic levels.

Strong earnings lifted interest coverage ratios, S&P said. “But with persistent inflation forcing the Fed to raise rates further, the earnings outlook is weaker.”

In other words, the upward movement in interest coverage over the past two quarters and the decline in leverage ratios may be short-lived.

Bank of America plans S&P 500 earnings will rise just 2% year over year in the third quarter. And in Robert Phipps’ Capital Outlook of September 27, the director of Per Stirling Capital Management said corporate earnings expectations for 2023 “are still far too optimistic at 8%, when we actually expect flat to negative earnings next year.”

If that happens, paying off debt will likely be far down a CFO’s priority stack when it comes to using cash. Unless, of course, a business is desperate to maintain a credit rating or breach a loan covenant.

Overall, the data and analysis coming from the credit markets point not to healthy balance sheets, but to a distressed future for heavily indebted companies.

In his Global Financial Stability Report released on October 11the International Monetary Fund has indicated that credit metrics in the U.S. leveraged loan market, in particular, suggest a next wave of defaults.

According to the IMF, more than half of the leveraged finance market is now made up of companies with a “B” credit rating (typically two or three notches in speculative territory). Partly due to private credit market competition, the fund’s report says, a third of new leveraged loans have debt-to-EBITDA ratios above six times earnings (4x to 5x is red flag territory). ).

“The creditworthiness of some of these assets,” according to the IMF, “may be tested in times of recession.”

Sallie R. Loera