Junk Firms Face Steepest Debt Costs In Decade As Economic Reckoning Arrives

For corporations with junk credit ratings, the cost of debt servicing has skyrocketed, reaching levels not seen in over a decade. This surge can be attributed to the Federal Reserve's rate-raising campaign. And it might force some companies to reevaluate capital structures. 

Bloomberg cited an S&P Global Ratings report that outlined junk-rated firms are paying an effective rate of 6.1% on debt, up from 5.1% last year. The 6.1% rate is the highest interest on debt since 2010.

Surging interest rate costs will likely force companies with heavy debt loads to rethink their capital structures:

"If funding costs remain higher for the long term, this may force a rethink of capital structures and bring more focus on protecting cashflows."

 "We could see greater efforts to reduce net debt, more use of equity in M&A, and more caution over capital expenditure," said Gareth Williams, head of corporate credit research at S&P.

Junk-rated firms will have to reconsider their business plans developed during a low-rate environment while the era of cheap money has been over for 14 months and will likely be over for some time as the Fed wrestles with inflation. Bloomberg pointed out a perfect storm forming:

"High-yield firms in particular are having to deal with the dual impact of costly payments from floating-rate debt and lower earnings."

Some of the highest rises in interest paid versus total debt are in developers and housebuilders, healthcare, aerospace, and technology firms. 

The decade of a debt-fueled expansion has come to an abrupt end. And this means pain for zombie companies:

"The transition may be the hardest part. More vulnerable credits with capital structures built for a world of near-zero rates are more likely to default," Williams said.

These junk-rated firms will need to eliminate debt and scale back growth as the cost of servicing debt and interest rates on the line of credit are sky-high. 

S&P warned late last year a corporate default wave would erupt in even a mild recession.