Over the past 18 to 36 months, the Federal Reserve’s shifting policies have significantly impacted interest coverage ratios within the investment-grade credit space. From March 2022 to September 2024, the Fed’s aggressive rate hikes, aimed at curbing inflation, led to increased borrowing costs and higher interest expenses for corporations. As a result, many investment-grade companies experienced a decline in their ability to meet interest obligations. This was particularly evident in heavily leveraged sectors such as energy and real estate. For example, the investment-grade energy sector saw its coverage ratio fall from 4.28 to 2.99 over this period (source).
With the Fed’s recent pivot to rate cuts in September 2024, borrowing costs have started to ease, providing some relief to corporate borrowers. This shift offers an opportunity for companies to refinance high-cost debt at more favorable terms, which should gradually improve their ability to service interest obligations. However, the full impact will take time to materialize as firms adjust their capital structures and take advantage of lower rates.
The Fed’s policy shift presents investment-grade firms with a chance to regain financial flexibility. Sectors previously strained by high borrowing costs, like energy and real estate, stand to benefit most. However, the extent of improvement in coverage ratios will depend on each company’s debt strategy and the overall economic environment. Prudent financial management will be essential as firms navigate this evolving landscape marked by rate shifts and economic uncertainties.
By Ben Avor, CFA
