Fixed or floating

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					      Corporate debt

Fixed or floating ?
Companies’ financial attributes and peer practices may influence corporate debt-mix decisions.
Chuck Brobst and Sylvia Huang look at securities filings to see if relationships can be detected

                          t is common practice for companies            fixed/floating mixes were examined in            dustry groupings include manufacturing,
                          to issue both fixed- and floating-rate        light of their industry, credit ratings, in-     food, health care, oil and gas, retail,
                          debt. Whether its total debt issuance         terest coverage and financial leverage.          telecommunications, utilities, and non-
                       leans more toward fixed- or floating-rate                                                         energy commodity and chemical. Table
                       exposure might signal the company’s              Aggregate results                                B shows the fixed debt proportions, fi-
                       view on interest rates. Issuing more than        Of the Fortune 100, we examined the              nancial leverage ratios and interest cov-
                       50% of debt as fixed-rate indicates a view       55 non-financial companies that report           erage ratios for these industries.
                       that rates are on the rise. Alternatively,       adequate information to provide for                  For many industries, the range of
                       issuing more than 50% floating-rate debt         meaningful analysis of their fixed ver-          debt mixes is substantial, indicating that
                       indicates a view that interest rates are on      sus floating debt structure.2 In aggre-          optimal debt mix is not widely agreed
                       the decline. A 50:50 mix is often consid-        gate, these companies report that more           upon for a given industry. Only retail,
                       ered a neutral interest rate position.           than 56% of their hedged debt carries a          telecommunications, utility and non-
                           In practice, as corporate executives         fixed rate, with individual proportions          energy commodity and chemical indus-
                       determine what proportions of debt are           ranging between 0% and 94% (see table            tries demonstrate reasonably homoge-
                       appropriate, they consider their expo-           A and figure 1).                                 neous debt mixes across all observed
                       sure to interest rates, balance sheet du-            Interest coverage, as measured by            companies. All industries except manu-
                       ration, debt and interest coverage               EBITDA (earnings before interest, taxes,         facturing have an average fixed-debt pro-
                       ratios, the current interest rate envi-          depreciation and amortisation) divided           portion above 50%.
                       ronment, and peer group practices.               by interest expense, averages 14.1 for
                       Though similar companies may use                 these companies, but ranges from                 Results by category
                       similar information to determine the             1.8–72.8 overall. The credit ratings of the      In general, the higher a company’s cred-
                       debt mix, the conclusions are often sub-         companies range from the highest qual-           it rating, the lower the share of fixed-rate
                       stantially different.                            ity to below-investment-grade. Financial         debt it carries (except for non-investment
                           The objective of this article is to pro-     leverage, measured by the ratio of debt          grade and non-rated companies).
                       vide a reference for the array of debt           to total debt and equity financing, aver-            This result probably reflects highly
                       mixes elected by model companies and             ages 41% and ranges from 0–73%.                  rated companies’ ability to take greater in-
                       to examine the variance in such practices            To identify similarities in peer practices   terest rate exposure in an attempt to cap-
                       relative to other critical financial attribut-   and the impact of industry interest rate         ture the expected benefits of lower,
                       es. This report provides a snapshot of the       sensitivity on debt mix, we analyse the          floating-rate interest expense. Notably,
                       fixed and floating interest rate mix of For-     mixes for groups of companies organised          eliminating two outliers from the non-in-
                       tune 100 companies.1 These companies’            into different industry categories.3 The in-     vestment grade category increases its av-
                                                                                                                         erage fixed-rate allotment to more than
                        A. Summary results                                                                               75%, further confirming that average fixed-
                                                                                                                         rate debt increases as credit rating falls.
                                                                                                                             However, within each credit category,
                         Category                             Low               Average             High
                                                                                                                         the proportion of fixed-rate debt issuance
                         Fixed debt proportion                 0%                 56%               94%
                                                                                                                         varies widely, indicating that comparably
                         Interest coverage                     1.8               14.1               72.8
                                                                                                                         rated companies may arrive at substan-
                         Credit rating               Below-investment grade                      AA or better
                                                                                                                         tially different debt mixes depending on
                         Financing leverage                    0%                 41%               73%
                                                                                                                         their financial objectives.
                                                                                                                             Debt mix was examined in relation to

                        B. Industry profiles

                         Industry                            Fixed debt proportion                   Financial leverage ratio             Interest coverage
                         Sectors               Frequency Average (%) High (%) Low (%)                Avg        High       Low      Avg (%) High (%) Low (%)
                         Manufacturing             5       49.3        91.0      10.6                0.46       0.58       0.37       8.0        15.2      1.8
                         Food                      8       52.0        79.0      12.1                0.56       0.73       0.28       9.9        22.8      3.3
                         Health care               8       58.4        88.2      33.6                0.22       0.28       0.14      22.6        64.3      3.2
                         Oil and gas               6       63.8        94.2      34.5                0.36       0.53       0.16      23.9        63.7      8.6
                         Retail                    5       62.7        80.5      44.3                0.41       0.73       0.18      12.2        34.3      2.4
                         Telecommunications        5       59.4        73.0      46.9                0.40       0.62       0.20      11.8        15.2      5.8
                         Utility                   5       68.6        85.5      50.5                0.62       0.73       0.50       4.0         5.5      2.7
                         Commodity and chemical    5       56.3        63.9      45.1                0.50       0.73       0.39       6.5         9.5      3.5

                                                                                                                                                             Corporate debt

each company’s interest coverage to de-                interest rate exposure. The variation of                          nancial strength to endure additional in-
termine whether there is a link between                individual results about the averages is                          terest rate exposure. However, even ac-
a company’s use of fixed-rate debt and its             again substantial.                                                counting for these attributes, the
interest burden relative to cashflow. As                                                                                 proportions of fixed- and floating-rate
shown in table D, as interest coverage in-             Summary and conclusions                                           debt vary widely, suggesting that there is
creases, the average fixed-rate portion of             As summarised in table F, average debt                            no scientific answer to the question of
debt tends to decline. Companies with                  mix seems to be moderately influenced                             what is an appropriate debt mix. ■
coverage ratios less than five times ap-               by interest coverage, credit rating and use
pear to depart from this trend.                        of leverage, and in some cases by indus-                                 Chuck Brobst is a Chicago-based
    However, by again removing two out-                try grouping. In general, companies use                            principal and Sylvia Huang a New York-
liers (companies having less than 20%                  more floating-rate debt when other fi-                              based analyst in the Bank of America
fixed-rate debt allotments), the average               nancial measures indicate sufficient fi-                                 risk management advisory group
for this group rises to more than 69% (and
a minimum of over 50%).4 Therefore, the                 C. Fixed debt mix by company debt rating
evidence suggests that companies with
greater interest coverage are, on average,                                                                                               Fixed debt proportion
                                                                Company debt rating                Frequency                       Average (%) High (%) Low (%)
willing to add proportionately more in-
                                                                AA or better                           11                            46.3        88.2       12.12
terest rate exposure in exchange for po-                        A                                     20                             53.6        83.8        0.00
tentially lower total interest expense.                         Investment-grade – sub A               16                            66.2        91.0       10.59
    Not surprisingly, given the relation-                       Non-investment-grade and non-rated      6                            55.7        94.2       12.59
ship between interest coverage and debt
mix, increased leverage ratios are asso-
ciated with increased proportions of                    D. Fixed debt proportion by interest rate coverage
fixed-rate to total debt. This indicates
again that companies with greater debt                          Interest coverage                                                 Fixed debt proportion
burdens tend to have less tolerance for                         Range                               Frequency           Average (%)      High (%)       Low (%)
                                                                0–5x                                    15                 62.3            91.0          12.6
1 Only recently have the majority of companies
                                                                6–10x                                   12                 65.5            85.9          41.6
begun reporting financial positions with                        11–15x                                  11                 53.7            83.8          12.1
sufficient transparency to permit the analysis of               16–20x                                   4                 43.3            94.2          10.6
net fixed and floating interest rate exposure. Of               > 20x                                   11                 44.6            88.2           0.0
the companies included in the Fortune 100, 55
provide sufficient information to identify the
fixed- and floating-rate mix, including swaps
positions.When available, such information is           E. Fixed debt proportion by financial leverage
generally contained in company 10-Ks/annual
reports, and not necessarily in quarterly reports.              Financial leverage                                                Fixed debt proportion
Because fiscal year-ends differ, the timing of the
                                                                Range                               Frequency           Average (%)     High (%)       Low (%)
reported positions analysed here differ somewhat.
However, of the 55 companies analysed, 35                       0–0.25                                  10                 45.9           88.2           0.0
reported as of December 31 and another five                     0.26–0.50                              26                  55.0           94.2          10.6
reported on December 30. Only nine of these                     0.51–0.75                               17                 63.9           91.0          12.6
companies reported more than 35 days from
December 31. For our analysis, we assume that
debt structure for these companies did not
change materially during this small window of           F. Summary findings
time. Financial companies were excluded from
the results                                                                                            Average fixed-to-total debt                   Variance
2 Fixed/floating mix is determined based on
                                                                Industry                                       Inconclusive                            High
outstanding long- and short-term debt, adjusted                 Debt rating                          Higher rating ➝ lower fixed mix                   High
for information furnished on companies’ swaps
                                                                Interest coverage                   Higher coverage ➝ lower fixed mix                  High
positions. It should be noted that some companies
use interest rate caps and floors, altering the                 Financial leverage                  Higher leverage ➝ lower fixed mix                  High
profile of floating-rate debt. In some cases, a
judgement was made that such interest rate
option positions effectively converted floating-rate
exposure to fixed-rate exposure                         1. Distribution of companies’ fixed debt proportions
3 Every effort was made to assign the companies
into an industry category. However, three of the
companies did not fit suitably. In addition, five
companies were assigned to a ‘technology’                               20
classification, but that industry is not presented
                                                        Frequency (%)

because three of the five members reported little                       15
or no debt, and we determined that the
remaining two members did not adequately
represent the industry                                                  10
  The two companies eliminated exhibited fixed-
to-total debt ratios of about 13% and 19% with                          5
leverage ratios (debt financing / (debt + equity
financing) of 46% and 61%, compared with the
aggregate average of 41%. Heavy reliance on                             0
                                                                             0–10   11–20   21–30     31–40     41–50      51–60     61–70   71–80   81–90      >91
floating-rate debt by these companies may be an
attempt to capture the usually lower floating rate                                                       Fixed-rate debt proportion (%)
to reduce interest expense and improve ratios

                                                                                                                               WWW.RISK.NET ● MARCH 2002 RISK         ●   INTEREST RATE RISK S17

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