Central banks across the US, UK and Europe have been signalling interest rates would remain higher for longer since the start of the final quarter of 2023 even with a pause from all three at its latest respective monetary policy meetings.

Higher rates come with higher costs associated with debt, as companies near maturities of the loans secured before the Covid-19 pandemic or as the virus was spreading worldwide.

This can lead to corporates facing significantly higher costs when it comes to servicing their debts and securing refinancing once reaching maturity.

According to figures compiled by the UK Department for the Economy, the number of registered company insolvencies in December 2023 was 2,002, 2% higher than in the same month in the previous year.

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This was higher than levels seen while the government support measures were in place in response to the coronavirus pandemic and also higher than pre-pandemic numbers.

Yet, industry players outlined several factors which could make things easier for companies, and in turn, avoid being penalised by the higher rates environment.

April LaRusse, head of investment specialists at Insight Investment, noted that many corporate issuers used low levels of interest rates “locked in” advantageous funding during the pandemic for an extended period of time.

This resulted in longer maturity profiles and led to a lack of issuance, which sparked concerns around credit markets’ ability to face a future maturity wall.

However, she highlighted there was “no clear maturity wall”, especially in US markets, as debt maturities are spread over a long period of time.

“This should allow corporates to smooth their funding costs and make gradual adjustments to their business models to deal with higher rates,” LaRusse noted.

“When we compare average debt coupon levels in the US with market yields over time, it demonstrates that aggregate funding costs change far more slowly than market rates, and the picture is similar in Europe.”

Mike Scott, head of global high yield and credit opportunities at Man GLG, agreed with LaRusse, arguing the only companies that may struggle to secure financing will likely be those “established on the basis that rates would be close to zero for longer”.

Overall, Scott said around half of the maturity wall over the next five year is “high-quality, BB-rated risk”; and although it may be more expensive to refinance, “we do think these companies retain the financial flexibility to manage with the higher interest rate cost burden”.

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He highlighted a different situation for leveraged loans, however, as only 21% of the maturity wall for this category over the next five years comprises BB risk.

As a result, Scott argued debt is likely to come at a much higher cost, but he was positive of companies’ ability to refinance, especially those in the high yield space.

Such a situation could also provide opportunities for investors to buy debt at “deep discounts to par”, he added, “provided you believe the company can refinance”.

“The resultant pull to par could lead to substantial capital appreciation on to of income returns,” he said. 

LaRusse also argued many companies have benefitted from high inflation and high interest rates, which led to a surge in revenue growth and, as such, allowed them to deleverage their business models.

She said: “In euro-denominated high yield for example, debt-weighted interest coverage is close to multi-decade highs. In our view, these factors make credit markets far less vulnerable to the higher rates environment than some commentators would suggest.”

Man GLG’s Scott also highlighted European credit, expressing a preference for it over US credit. He argued that, generally, it is of higher quality with a lower level of leverage, due to a more conservative capital structure as several European businesses are often family-owned.

He continued: “Europe also trades at a significant discount to US, with Pan European Currency HY trading around 160 bps wider than their US counterparts, despite what we see as better fundamentals.

“It is certainly not a time to buy the entire market and we believe dispersion between sectors, geographies and single names has created opportunities. We continue to see value in financial companies in Europe, which are robust compared to their US counterparts, and which have the right business models for the current interest rate cycle.”

Despite being more cautious on non-financial cyclicals, Scott highlighted real estate as a sector of interest, since it remains “under pressure”. With valuations falling and spreads at 779 bps, he argued there are “some attractive opportunities in both performing and special situations”.

Another factor that could mitigate corporates’ ability to service their debts and secure refinancing is the current growth in private markets, argued Azhar Hussain, head of global credit at Royal London Asset Management.

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He noted companies in the UK, US and Europe are “disproportionately higher-rated compared to history”, with an increase in the average credit rating of public credit markets over the last decade.

As such, Hussain highlighted the resilience of most borrowers, despite a spike in funding costs, thanks to the “unprecedented” fiscal and monetary support during the Covid pandemic.

But the role of the private debt space has also significantly increased over the last few years, he noted, providing a “much-needed refinancing outlet for many of the more leveraged names”.

That is why Hussain expressed confidence in the debt market, as he argued even the most stressed names could turn to private markets to take on risk that public markets are “no longer willing to absorb”, leading to a deferral, or even the elimination, of defaults.

He added: “Whilst dry powder continues to proliferate in private markets starved of investment opportunities, public markets should continue to prosper by deferring problems to the private markets.”