Regime shift: How exposed are corporate bond issuers to higher interest rates?

Despite the significant rise in interest rates over the last year, corporate bond markets have been relatively calm. Notwithstanding benign conditions, issuers now face a higher cost of borrowing, so it’s worthwhile assessing the implications for issuer credit fundamentals, and in turn what that might mean for investors.

This paper assesses both the refinancing requirements for corporate bond issuers and the starting point for interest expense affordability. We look globally across sectors for the investment-grade and high-yield markets.

We show that corporate bond investors can take some comfort from aggregate interest coverage ratios (ICR) starting from a point of strength and corporate bond refinancing requirements being well spread out. But investors should not be complacent as there could be potholes.

Within investment-grade, corporate bond refinancing requirements are below average in the coming years, and issuers are starting from a position of relative financial strength. This may go some way to explaining why credit spreads are not wider in the face of high inflation, weak growth, and tight financial conditions.

For high-yield issuers, it’s a different story. Although there’s no impending large maturity wall this year or next, a significant amount of bonds are due to mature in the two years which follow (chart A). The proportion of the high-yield market which needs to be repaid or refinanced within a three to five year period has risen to its highest level since at least 2006. This is when borrowers will most feel the pain if yields stay elevated. Some reassurance can be taken from the fact that, like investment-grade, the median borrower starts from a position of high interest cover, but not all sectors are in such strong shape – for example transport and leisure (chart B).

This does not mean that a wave of defaults is coming, or that borrowers in others sectors have nothing to worry about. Individual company specifics always matter and high level sectoral analysis can only tell you so much. More expensive borrowing costs risk putting individual borrowers under pressure across all sectors. Now is the time when active management has the potential to make a big difference.

The full paper is available here.