In a narrow window between the late summer of 2020 and the winter of 2021, it looked like Denis O’Brien had pulled it off. 

He had managed to restructure Digicel’s debts in May 2020, forcing a hefty write-down on creditors. The only catch was that he needed to refinance a chunk of the debt before June 2023, on the pain of losing 47 per cent of his equity.

It was not long after that, when the initial panic over Covid died down, that there began a bull market in risky bonds. Great news for O’Brien. Between May 2020 and June 2021, some Digicel bonds more than doubled in value. That month, Fitch upgraded some of Digicel’s credit ratings.

But beginning in January of this year, the debt markets have turned. It’s hard to overstate how abrupt and sharp this move has been. It’s not an exaggeration to call it unprecedented. 

The following chart shows how sharply yields on US government 10-year bonds, a bond market benchmark, have changed. It is the sharpest rise in yields since the data begins in 1965.

US government bonds are the least-risky asset. Corporate debt is riskier. Distressed corporate debt — the category Digicel belongs in — is riskier again. O'Brien has always come out fighting on debt negotiations and has pulled it off before, but he will be operating in a completely different environment. The following chart from the end of October shows the yield on some Digicel bonds, maturing in 2025. These bonds pay a coupon of 8 per cent, and were yielding 72.5 per cent. That means at the time they were trading at a 59 per cent discount to face value.

A bond from Digicel Ltd, with an 8 per cent coupon, due to mature in 2025, is yielding 72.5 per cent

Digicel is an extreme example of a problem faced by most businesses this year. Debt has suddenly gotten much more dangerous.

Companies have a way of adapting to their climate. Ireland in the 1990s was a good place to build a factory. It had cheap labour and low taxes. American manufacturers flourished. 

Then in the 2000s, Ireland was a great place to borrow money and buy land. A good time for the property barons.

The world since 2010 has been a time of very low-interest rates. Any company big enough to tap into global credit markets has had the option to borrow lots of money very cheaply. Companies have responded: Corporate debt has never been higher as a percentage of global GDP, according to the IMF. 

Certain business models have flourished: loss-making companies promising a big payback in the distant future; companies who build cheap financing into their offer to customers, such as buy-now-pay-later apps or personal contract purchase cars.

Traditional businesses have been tempted by cheap debt too. They use it as a tool for dialling up risk and returns. Dull businesses that want more excitement can use debt to juice returns to shareholders — and their risk. That's why leverage is usually greatest in safe industries like utilities. Already-risky industries like construction, by contrast, don't use much leverage.

The classic way companies get into trouble is that they go through an unexpected slowdown and they can't afford their interest payments. There's always a risk that random bad luck might bankrupt a heavily leveraged company. But for most companies, it's worth the risk. 

What we're seeing now is tighter credit conditions getting imposed on all companies at once. The whole climate has shifted. Companies that had been set up for one type of environment find themselves in a different one. Very suddenly, the days of cheap debt are over.

The new climate is one of high interest rates, high and unpredictable inflation, and high energy costs. The question is, what happens next to the Irish companies that built up piles of debt during the good years? Which companies will find it hardest to adapt to the new climate?

Why rates are up

But first — why is the economy changing? As we've seen, European corporate bonds have sold off. I could show you similar charts for the US or UK.

A bond is the promise of a stream of payments for a fixed period of time, with a big payment at the end. The small regular payments are called coupons and the big payment is called the principal. 

Bond investors worry about three things. The first is that the company will break its promise and not pay them back. The second is that inflation will erode the value of the fixed stream of payments. The third is the return they are missing out on by not investing in ultra-safe government debt.

The thing that has freaked out bond investors most in the last year is the rise of inflation. Corporate bonds have suffered, but so too have sovereign bonds. That corporate and sovereign debt have both fallen together indicates investors aren't suddenly worried about defaults by corporations in particular. Which leaves inflation as the culprit. 

Sovereign bonds — particularly the bonds of big, rich countries like Germany or the US — are less risky than corporate bonds. Over the last decade, the attraction of corporate bonds to investors was that they offered a better yield than government bonds. But now that government bond yields have risen, lending to companies looks less attractive. 

To fight inflation, central banks have had to raise rates. They've also been selling down their portfolio of corporate bonds, which they bought during the pandemic in an effort to support the economy. Interest rates will stay uncomfortably high until inflation is licked — something markets are forecasting will take two years or so. After that, rates will probably fall a bit, though not to the very-low levels we became accustomed to in the 2010s. The following chart from October shows market expectations of future interest rates.

The upshot is that companies will be stuck with much higher rates, plus inflation, for the next year or two, followed by moderately higher rates.

Debt measures

In this new world, obviously, the more debt a company has, the more vulnerable it's going to be.

I went through the financials of the major Irish-based and Irish-owned companies to see which ones, if any, are the most impacted. There are a few different ways to test it.

One is to look at the book value of the company's debt compared to its equity. This simple measure tells you how much the company relies on debt to finance itself. 

Another is to look at the size of net debt — ie debt minus cash — relative to profits. This number, the net debt-to-Ebitda ratio, tells us much debt a company has relative to the earnings which will be used to service it. Though it varies by industry, net debts of less than two times Ebitda would be considered small, net debts of greater than six times Ebitda would be considered big.

Another way is to look at interest payments relative to operating profit, or what's called a coverage ratio. This is a variant on net debt-to-Ebitda since it's showing a debt measure relative to a profit measure. The difference is that the coverage ratio takes into account the rate of interest on the debt. A loan with a 12 per cent interest rate is riskier than one with a 2 per cent one, and the coverage ratio captures that difference. 

For companies who issue bonds on the public markets, another way is to look at how those bonds are trading. How do investors rate their chances of getting paid back?

Another way is to look at when debts come due. Interest payments are one thing — even a stressed company can usually find the cash to pay interest — but principal payments are another matter. The principal is the big lump sum that must be repaid when a bond matures. When it comes time to repay the principal, what companies normally do is issue a new bond to pay off the principal on the old one. This strategy works almost all the time. But it breaks down when financial conditions, particularly credit conditions, change during the period of the bond. Right now, the danger for companies is having to refinance a big pile of bonds during the next 12-24 months.

The Irish debts

Looking at national statistics, you'd be left with the impression that Irish corporates are more heavily indebted than the European average. However, as is often the case, the Irish numbers aren't as they appear. They include figures from foreign multinationals, which do a lot of intracompany lending, distorting the figures. In a 2012 paper, economists at the Central Bank of Ireland estimated that intracompany debt exaggerated Irish corporate debt by 15-20 per cent.

So I checked them individually. I looked at the biggest publicly traded Irish companies, plus the ten biggest private companies, plus a handful of big Irish-controlled companies overseas.

When you look across Irish public companies as a whole, the good news is that they're relatively low in debt. The average net debt-to-Ebitda ratio for Irish public companies is 2.1. That compares to an average of 4.0 for the 500-1000th ranked US public companies, which, although bigger than Irish public companies, are a reasonable comparison. Also, bear in mind that interest rates in the US have been one or two per cent higher than in Ireland for the last ten years or so. 

This is reflected in the interest coverage ratio, which shows how many times interest payments can be paid out of operating profits. Irish companies' profits are about 5.1 times greater than their interest payments, compared to US companies whose operating profits are 1.9 times interest.

Some big companies are missing from the list. Banks and aircraft lessors are types of financial institutions, and net debt to Ebitda isn't the right metric for them. Others, like Musgrave and Ornua, are in a business with lots of working capital, and again net debt isn't the best metric for them. 

Net debt to Ebitda is one thing. Another important question is, when do debts mature? When a company's debt matures, it typically has to repay the principal in one go. 

When times are good, this usually isn't a problem, because companies can take out a new loan to repay the old one. But when the company gets into trouble — or interest rates go up — there can be issues. 

Two companies could have identical net debt-to-Ebitda ratios. But depending on when their debts come due, one could be in much greater danger than the other. Ideally, debts would come due gradually, and not in one big tranche. And ideally, debts wouldn't be coming due in the next year or two, when interest rates are expected to spike.

The following chart shows which Irish companies are most exposed to refinancing in the next year, when rates are expected to rise. 

Under the most stress are companies that have lots of debt relative to earnings and lots of debt coming due this year. 

Bear in mind that this analysis is from a particular point in time, in late October. Most of the key figures were taken from 2021 annual reports; some were sourced from SharePad. In the case of Ryanair, whose 2022 first-half results were released at the beginning of November, the business has shed most of its debt since it completed its 2021 financial year in March. The company managed to get rid of its debt before it became a big problem.

Under levered?

A strange conclusion of the research is that most Irish companies looked to be under-levered relative to American ones. That is, they made much less use of debt than American companies of about the same size.

At a time of rising rates, under-levered Irish companies will be feeling pretty good about themselves. Low debt makes them more robust when conditions get worse.

But it's worth pointing out that an aversion to debt might be a bad thing, in the round. Yes, debt makes companies more fragile, but it also makes them more efficient. 

Companies need to be funded. They can take money from either debt investors or equity investors. Equity funding is safe — but it's expensive. Equity investors demand a big return to compensate them for their risk. Debt funding, by contrast, is cheap. So by excluding debt investors, companies cut off a big source of cheap funding. Multiply that across the whole economy and you get fewer and smaller companies than otherwise would have been the case.

What's more, under-levered companies are at risk of becoming targets for corporate takeovers. A 2000 paper by Safieddine and Titman found that companies that took on a lot of debt (in an effort to protect themselves from corporate takeovers) had more free cash and a better-performing stock price than companies that weren't targeted for takeovers, and didn't take on debt.

The majority of heavily leveraged Irish firms (based on either net debt to Ebitda or coverage ratios) are either international facing or internationally-owned: Avolon, Digicel, Ardagh, Tullow Oil, Mater Private, Beauparc, Flutter. 

This suggests to me that Irish companies don't have low leverage because Irish managers dislike debt. The Irish companies that can borrow money from outside Ireland — whether because they've been bought by private equity, or because they listed on an overseas stock exchange, or issue their own bonds — are the ones that have been strong on debt. 

Size is clearly a factor in this — bigger firms can access debt on better terms than small ones. But mid-sized firms like Tullow Oil (market cap: £631 million), Beauparc (which I valued last summer at €539 million) and Mater Private (€964 million) indicate size isn't the only factor. Most of the Irish companies that are able to borrow money freely are also willing to do so. This implies that many domestic Irish companies' low levels of debt is not a choice freely made.

Why might this be? The legal system gets some of the blame for high mortgage interest rates in Ireland. But unlike with mortgage debts, courts in Ireland have no problem enforcing commercial debts.

The Irish companies that have found themselves in the most trouble are the ones that tapped bond markets. Bond market investors have two relevant qualities. They only invest in companies above a certain size, and they lend on better terms than other investors. Some Irish companies couldn't resist them.

We've already seen the rise in Digicel bond yields. Less extraordinary, but still dramatic, is the rise in yields on Ardagh's 2027 bonds:

Yield on an Ardagh bond with a 5.25 per cent coupon, maturing in 2027

And Aercap's 2032 bonds:

Yield on an Aercap bond with a 3.3 per cent coupon, maturing in 2032

And Avolon's 2027 bonds: 

Yield on an Avolon bond with a 2.528 per cent coupon, maturing in 2027

The abrupt change in credit markets could have been a dangerous moment for corporate Ireland. But, whether they couldn't or wouldn't leverage themselves heavily, most Irish firms should come through it okay. An open question is whether corporate Ireland would be better off with more credit, more risk, more efficiency, more fragility, higher returns to shareholders, and more companies funded.