Higher interest rates and corporate bonds

Despite an increase in interest rates over the last year, corporate bond markets have remained mostly steady. However, issuers are now facing higher borrowing costs, and asset manager Schroders analyses the implications for issuer credit fundamentals and the consequences of investing in corporate bonds.

“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,” writes Harry Goodacre, Strategist, Strategic Research Unit at Schroders.

When it comes to investment-grade, Goodacre notes that the corporate bond refinancing requirements are lower in coming years, with issuers being are in a position of relative financial strength. This, he claims, explains why credit spreads are not wider despite rising inflation, sluggish growth, and tight financial conditions. 

However, for high-yield he paints a different picture. This is because a considerable amount of bonds will mature in the two years following 2024. 

Along with that, the asset manager says that the proportion of the high-yield market bonds 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…the median borrower starts from a position of high interest cover, but not all sectors are in such strong shape,” opines Goodacre. 

Looking forward, Goodacre contends that the current situation does not mean that a slew of defaults is inevitable in the future. “Individual firm characteristics are always important…Higher borrowing costs risk placing individual borrowers under strain across all industries,” he concludes.

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