Rising Corporate Debt Defaults Signal Concerns Amid Global Economic Slowdown

The mounting threat of corporate debt defaults has long been downplayed by resilient credit markets, but the situation is taking a concerning turn as more companies face downgrades to junk credit ratings, leading to higher borrowing costs. Several high-profile cases underscore the severity of the issue:

  • Retailer Casino is currently engaged in court-backed discussions with creditors over its 6.4 billion euros ($7.19 billion) net debt
  • Britain's Thames Water struggles with a massive debt pile of 14 billion pounds ($18.32 billion)
  • Swedish landlord SBB has also been downgraded to junk status, exacerbating a property market crash that poses significant risks to Sweden's economy.

Risk-On Attitude

Surprisingly, despite the rising default risks, investors seem unperturbed as the cost of insuring exposure to a basket of European junk-rated corporates recently reached its lowest point in over a year. This apparent complacency has raised concerns among experts, such as Markus Allenspach, head of fixed income research at Julius Baer, who points out that the number of defaults in the first five months of 2023 already matches the total for the entire year of 2022. Nevertheless, high-yield bonds continue to attract inflows, indicating the ongoing confidence in the market.

  • S&P Global predicts that default rates for U.S. and European sub-investment grade companies will rise to 4.25% and 3.6%, respectively, by March 2024, up from 2.5% and 2.8% in March of the current year.
  • Hopes that the world economy will avoid a severe downturn, combined with the belief that aggressive rate hikes will soon abate, are fueling this positive sentiment.
  • However, analysts caution that the full impact of rate increases has yet to be felt, and corporate bond yields should command a higher premium to account for the risks.

Ignoring Risks

Guy Miller, chief market strategist at Zurich Insurance Group, argues that corporate credit spreads remain excessively tight and do not adequately reflect the existing risks. He notes that a considerable number of U.S. public and private companies with significant liabilities have already filed for bankruptcy protection in the current year, pointing to a potential surge of bankruptcies exceeding 200 by year-end, comparable to levels witnessed during the global financial crisis and COVID-19 pandemic.

  • While some companies have extended the maturity of their debt during the low-rate environment, providing them with breathing space, those with impending debt maturities will face costly refinancing.
  • ABN AMRO highlights that the average maturity of European high yield corporate bonds has reached a record low of nearly four years in May, compared to an average of just over six years between 2005 and 2007 when the European Central Bank raised rates.
  • In light of higher interest costs and imminent debt maturities, some firms are starting discussions with creditors to restructure their debt and turnaround their businesses to avoid immediate repayment or insolvency.
  • Despite the challenges, experts believe that the legal systems in place have evolved since the financial crisis, reducing the likelihood of disorderly business wind-ups.

However, not all firms may be able to weather the storm of substantial debt, rising interest rates, and declining profits. Bain Capital Special Situations partner, Elena Lieskovska, anticipates that Europe may face a slower recovery from the downturn, which is still approximately 12 months away from reaching its full impact.

Disclaimer

Please note that this article does not constitute investment advice in any form. This article is not a research report and is not intended to serve as the basis for any investment decision. All investments involve risk and the past performance of a security or financial product does not guarantee future returns. Investors have to conduct their own research before conducting any transaction. There is always the risk of losing parts or all of your money when you invest in securities or other financial products. Please note that the writer of this article is not registered as a financial advisor.

Credits

Photo by Markus Spiske / Unsplash.