“Assuming a similar outcome for outstanding bank debt of European corporate borrowers, the extra annual interest paid in 2024 will grow to more than EUR 40bn as European corporates are still much more dependent on bank financing than capital market debt funding,” Sebastian Zank, deputy head of corporate ratings at Scope.

The extra interest cost from durably higher borrowing rates will increase again in 2025 and 2026 as even more corporate debt comes up for refinancing. It is unlikely that inflation will have fallen far enough toward central banks’ targets to provide any relief from looser monetary policy and lower rates before 2025.

“Rising interest costs will test the resilience of corporate borrowers, from preserving credit ratings to avoiding default. Particularly under pressure are companies which had 3x interest cover or less when interest rates were ultra-low and those which have limited access to (re)financing,” says Zank.

Figure 1: Bond refinancing volume of Europe-based non-financial companies, Sep 2023 (EUR bn)

Source: Bloomberg, Scope

Median effective corporate lending rates have risen steeply

Companies need to earn the money to cover interest on debt that reflects higher base rates and higher risk premia particular to individual issuers and economic sectors.

As displayed in Figure 2, the average (volume-weighted) coupon of new bond placements in 2023 stands at about 500 basis points, which implies a 65% increase on interest when comparing it with the average bond which matures in 2023.

Likewise, the median effective corporate lending rate has already more than doubled by mid-2023 to around 4.0-4.5% from about 2% at YE 2022 (Figure 3) and is set to rise further as interest rate hikes feed through to the economy and old interest hedges expire.

Figure 2: Bond refinancing to have large impact on average coupons (volume-weighted)
Basis points

Source: Bloomberg, Scope

Compounding effect in the higher-for-longer environment

“We should also not forget the effect of compounding because companies have considerably more debt to refinance in 2023-2026 than they did in the preceding,” says Zank.

Assuming a full refinancing of maturing bonds in 2023 with a volume of about EUR 470bn at the average coupon of 495 basis points (volume-weighted) seen so far during the year will result in annual interest payments of EUR 23.4bn. This stands against interest burden of EUR 14.3bn which had to be paid on the bond volume that matures in 2023.

Figure 3: Cost of euro area bank financing has risen steeply
%

Source: ECB, Macrobond, Scope

Hence, companies will be burdened by an additional EUR 9.1bn of interest payments just for refinancing.

“If we assume that new bond issues placed in 2024 (only for refinancing purposes) bear an average coupon of about 500 basis points, issuers tapping the bond market will need to cover an increase in interest payments of 54% or a total amount of an additional EUR 8.2bn a year. Assuming a similar effect from the outstanding, much higher, volume pertaining to bank loans European corporates will face additional interest payments of more than EUR 80bn from refinancing efforts in just two years,” says Zank.

The effect will multiply further in 2025 and 2026 when an even larger amount of capital market debt will need refinancing, should central banks not significantly reduce base rates by then.

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