Laura Achiro and Neha Bora
Central banks in most advanced economies have tightened monetary policy by raising interest rates. Tighter financing conditions may make it harder for some businesses to refinance their debt or could mean they face less favourable terms when they do. This blog explores the extent to which bond maturities could crystallise these refinancing risks. Overall, UK corporate bond issuers appear broadly resilient to higher financing costs, but risks are higher for riskier borrowers particularly if the macroeconomic outlook and funding conditions were to deteriorate.
What is refinancing risk?
Paul and Zhou (2018) define refinancing risk as the potential inability of a borrower to secure new financing to replace existing debt coming due. Refinancing of bond debt is important as the UK corporate funding landscape has materially evolved since the late 2000s with companies reducing their dependence on bank borrowing and increasing their use of market-based finance (MBF). The share of bond finance to overall UK corporate debt has increased to 33% today, compared to the 22% share at end-2008.
We use a bottom-up data set to scale the extent of refinancing risk in the short (two-year) and medium term (five-year horizon). Our data set is constructed from matching issuance-level market data with company accounts data across a given group’s ownership structure. This approach provides a breadth of information including the UK bond issuer’s overall credit profile through a fuller mapping of the UK domiciled group and of the financing entities within that group, more up-to-date information on bond tenors after accounting for bond events (eg, called bonds ahead of maturity).
How large are bond refinancing risks in aggregate?
Around 15% of UK corporate bonds mature within the next two years (Chart 1). This is in line with recent historical averages, and slightly below the level prevailing before the global financial crisis (GFC). The picture is similar at the five-year horizon, with around 40% of bonds maturing – in line with recent historical averages. This is in part because the pre-GFC period was characterised by relaxed lending standards, and excessive leverage levels. However, in subsequent years, lessons learned from the financial crisis have paved the way for advances in risk management and more cautious lending practices.
Chart 1: Debt-weighted share of refinancing needs for UK PNFC bonds (a)
Sources: LSEG and staff calculations.
(a) The total UK PNFC bonds shown in this chart excludes non-rated and withdrawn bonds.
How much more vulnerable are riskier issuers?
Risks appear somewhat larger for high-yield bond issuers. These bonds comprise around £59 billion (17%) of our £352 billion data set which excludes non-rated and withdrawn bonds. These issuers are largely at a higher risk of default, and this is reflected in a higher cost of funding.
For the riskier subset of high-yield borrowers, the proportion of bonds maturing within two years is slightly above historical averages and GFC levels (Chart 2). Similarly, the proportion maturing within five years is also above pre-GFC levels.
The most recent data show an increase in bonds maturing across both time horizons. Generally, corporates typically do not wait until a bond matures to refinance it; they will seek to refinance ahead of maturity to ensure that they have continuity of funding. However, with tighter market conditions, such as higher interest rates, higher credit spreads and reduced investor appetite for riskier debt, corporates may find it difficult to secure favourable terms to refinance existing debt or debt coming due. This may lead to corporates choosing to delay refinancing until closer to the maturity date of their bonds.
Chart 2: Debt-weighted share of refinancing needs for high-yield UK PNFC bonds (a)
Sources: LSEG and staff calculations.
(a) The total UK PNFC high-yield bonds shown in this chart excludes non-rated and withdrawn bonds.
Charts 3a and 3b show the forward-looking maturity profiles for investment-grade bonds and high-yield bonds issued by UK private non-financial corporations (PNFCs). It’s interesting that the bars for both investment-grade and high-yield bonds are very similar sized across years.
Less reassuring though, around 57% of outstanding investment-grade bonds are rated BBB meaning that a one notch downgrade could reduce their rating to high yield. This could lead some investors to sell their holdings, for example if their mandate prevents them holding high-yield bonds. And this selling pressure could push bond prices down, beyond levels consistent with the downgrade news.
Chart 3a: Forward-looking maturity wall for UK investment-grade PNFC bonds (a)
Sources: LSEG and staff calculations.
(a) The total UK PNFC investment-grade bonds shown in this chart excludes non-rated and withdrawn bonds.
Within the population of outstanding high-yield bonds maturing between 2024 and by 2028, the vast majority are rated either BB (12%) or B (4%), and only 1% of the outstanding stock of UK corporate bonds falls into the riskiest bucket rated CCC or below (Chart 3b). While we might take comfort in the cohort of the riskiest bonds being relatively low, the trend in bond maturity reinforces risks around a vulnerable tail of corporates that need monitoring.
Chart 3b: Forward-looking maturity wall for UK high-yield PNFC bonds (a)
Sources: LSEG and staff calculations.
(a) The total UK PNFC high-yield bonds shown in this chart excludes non-rated and withdrawn bonds.
How much more expensive is bond issuance today?
To provide context, we use a hypothetical illustration where we see the typical issuance cost of high-yield bonds has increased to 10.25% (Bank Rate of 5.25% as at December 2023 plus high-yield OIS spread of 5%). The average tenor of a UK corporate bond is 10 years, so for comparison purposes we look at the cost of issuing a bond 10 years ago in December 2013. We find that the cost has more than doubled from 4.9% in 2013 (Bank Rate of 0.5% as at December 2013 plus high-yield OIS spread of 4.4%). Moreover, not long ago in 2021, high-yield bond issuers were paying even less, with issuance costs averaging 4.1% (Bank Rate of 0.25% as at December 2021 plus high-yield OIS spread of 3.9%).
Likewise, the current cost of issuing an investment-grade corporate bond has also increased to 6.72% (base rate of 5.25% plus investment-grade OIS spread of 1.47%) in December 2023. This represents an increase of 547 basis points since 2021 but remains significantly lower than the cost of issuing a high-yield bond. A corporate that is downgraded from BBB (investment grade) to high yield would therefore face a sharp increase in issuance costs.
What levers can corporates pull to mitigate refinancing risks?
In addition to official interest rates, the level of corporate bond spreads is a key determinant of the cost of refinancing. Recent data shows a downtick in corporate bond spreads as the yield premium over government bonds decreases (Chart 4). The fall in spreads for the high-yield bonds (purple line) is much sharper than for investment-grade bonds (pink line in Chart 4). Corporates might choose to take advantage of this and refinance their debt early while spreads are relatively low to lock them in. Or they may choose to wait in the hope that official interest rates fall. Doing so could prove risky, as previous episodes, including the GFC, show that bond spreads can increase significantly if the economy or financial markets experience stress.
Chart 4: Corporate bond spreads
Sources: ICE BofA Sterling High Yield Index (Ticker: HL00) and ICE BofA Sterling Industrial Index (Ticker: UI00).
Corporates could also choose to pay off debt with cash reserves rather than refinance it. Chart 5 shows that UK corporates have healthy cash reserves compared to the GFC period. At the aggregate level, UK corporate holdings of liquid assets have been on an overall upwards trend and increased by nearly £180 billion since 2019 to around £786 billion in 2023 Q3 (Chart 5). This build-up in liquid assets has been supported by robust growth in nominal earnings since the pandemic. This has reduced the aggregate net debt to earnings of UK corporates to a historic low of 119% (Chart 5).
Alternatively, corporates may choose to deleverage, or take other defensive actions such as reducing employment and investment which could reduce economic growth. So far, UK corporates have reduced their stock of outstanding bonds by 6% since December 2021 when the Bank Rate was first raised by the Monetary Policy Committee.
Chart 5: Liquid asset holdings by PNFCs
Sources: Association of British Insurers, Bank of England, Bayes CRE Lending Report (Bayes Business School (formerly Cass)), Deloitte, Finance and Leasing Association, firm public disclosures, Integer Advisors estimates, LCD an offering of S&P Global Market Intelligence, London Stock Exchange, ONS, Peer-to-Peer Finance Association, LSEG and Bank calculations.
Summing up
Overall, our analysis supports the Financial Policy Committee’s assessment in its latest Financial Stability Report that UK businesses are expected to be resilient overall to higher interest rates and weak growth. But that some firms are likely to struggle more with borrowing costs, including firms in parts of the economy most exposed to a slowdown, or with a large amount of debt. We find that risks are more elevated for high-yield bond borrowers, particularly at the five-year horizon.
Laura Achiro and Neha Bora work in the Bank’s Macro-Financial Risks Division.
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