Nov 20 (Reuters) – Investment bank Morgan Stanley (MS.N) is recommending that corporate bond investors focus on higher quality investment-grade and high-yield bonds headed into next year, as a wave of maturities poses risk to more junk-rated companies.
Morgan Stanley said it suspects the Federal Reserve has neared the end of its rate-hiking cycle, with a soft landing for the economy in the cards next year.
Even so, while the majority of junk bond maturing in 2023 did so successfully, another $73 billion are set to mature in the next 18 months, Morgan Stanley noted in a Friday report. Over the next six months, this is expected to rise to $125 billion.
Higher-quality junk bonds maturing next year will likely need to refinance at 125-250 basis points higher than their current interest levels, the bank added.
“Unlike loan borrowers, which have seen interest costs steadily creeping up, (high-yield) issuers will face a more dramatic ‘sticker shock’ of higher coupons,” the report’s authors noted.
The picture is more bleak for lower-quality junk bond issuers.
Between a fifth and a quarter of borrowers rated B3/B- by Moody’s and S&P have an average interest coverage of less than 1x. As maturities hit next year, 15-20% of this ratings class is likely to see downgrades to CCC, according to Morgan Stanley.
Downgrades will not be limited to junk issuers, Morgan Stanley added. The bank noted it expects between $75 billion and $100 billion in downgrades among A-rated high-grade companies to BBB, the lowest investment-grade rating from Moody’s.
“Leverage for IG companies is historically high, in the 2.25-2.30x range,” the report noted. “Without the post-Covid peak, these would be the all-time highs.”
On the leveraged loan front, Morgan Stanley said it expects a return in loan issuance next year for M&A and leveraged buyouts, buoyed in part by anticipated Fed rate cuts.
“Outside of refinancing, we forecast $130 billion to be placed in the TLB market for acquisitions and GCP/recaps,” the report’s authors wrote.
“While bank lending appetite may be slow to recover, the (broadly syndicated loan) market should benefit from Fed rate cuts.”
Reporting by Matt Tracy; Editing by Stephen Coates