Over $500 Billion Debt Risk!

Amidst market predictions pointing towards the end of the Federal Reserve's current rate-hiking cycle, the elevated interest rates are unlikely to retreat any time soon. Consequently, companies are facing significantly higher borrowing costs compared to the level experienced during the pandemic.

Earlier this year, the financial crisis in Europe and the United States became a focal point for many investors. The question remains whether the banking turmoil has subsided, as mounting corporate debt problems are surfacing: an increasing number of companies are seeing their credit ratings downgraded to junk status, resulting in even higher borrowing costs.

According to Bloomberg, large-scale business bankruptcies are occurring at the second-fastest pace since the 2008 financial crisis, falling only behind the early stages of the COVID-19 pandemic; over $500 billion in corporate debt risk is on the horizon, with expectations for further growth.

Consequently, fears are deepening on Wall Street, with potential implications for slower economic growth and pressure reemerging on a credit market that had just begun to breathe a sigh of relief.

According to a report from Moody's released at the beginning of this month, during the first quarter, 33 companies worldwide defaulted on their debts, marking the highest level since Q4 2020; 15 of these defaults occurred just in March of this year.

In Q4 2020, a total of 47 companies defaulted due to the impact of the pandemic. This year, a continued significant economic slowdown not only risks pushing businesses into default but could potentially trigger bankruptcy as well.

In Europe, many indebted companies are struggling to withstand pressures from inflation and elevated interest rates.

Reports suggest that Thames Water, the UK's largest water utility, has liabilities totaling £14 billion (approximately $18.3 billion). If the company fails to secure additional funding to address its debt, the UK government is contemplating nationalization.

Meanwhile, France's sixth-largest retailer, Casino, is embroiled in similar challenges, negotiating court-backed support with creditors. Currently, Casino's net debt stands at €6.4 billion (around $7.19 billion), with the company facing €3 billion in debt repayments due over the next two years, prompting warnings from both Moody's and Standard & Poor's about default risks.

Moreover, one of Sweden's largest commercial real estate companies, SBB, saw its credit rating downgraded to junk status in May, racking up liabilities of 81 billion Swedish Krona (approximately $7.95 billion), and is seeking buyers for parts or the entirety of its operations. Spain's largest private company, Celsa, is nearly €3 billion in debt (roughly $3.37 billion), with creditors submitting a restructuring plan now waiting for judicial approval.

Across the Atlantic, in the United States, ATM manufacturer Diebold Nixdorf declared bankruptcy last month, entering proceedings with over $2.7 billion in liabilities; healthcare giant Envision Healthcare and media company Vice Media also announced bankruptcies, stretching across various sectors.

“It’s not just a specific industry experiencing defaults; rather, a notable volume of defaults is occurring across various sectors. The circumstances depend on leverage and liquidity,” remarked Sharon Ou, Moody’s Vice President and Senior Credit Officer.

As of the end of June this year, S&P Global had tracked a total of 324 bankruptcy filings by U.S. companies, which is only slightly fewer than the 374 recorded for the entirety of 2022; from January to April, 236 business bankruptcy filings occurred, marking the highest figure for that timeframe since 2010, and more than double that of the same period last year.

When looking globally, S&P Global’s statistics reveal that corporate bankruptcy rates in England and Wales approach their highest level in 14 years, while Sweden experiences record highs not seen in a decade. In Germany, the number of bankruptcies surged nearly 50% in June year-on-year, marking the peak since 2016, and Japan’s bankruptcy rates reach their highest point in five years.

However, this may just be the beginning of a more significant issue.

Bloomberg’s data compilation indicates that nearly $600 billion in troubled debt is currently active globally, with a default rate under 15%; this means that more than $500 billion in debt may remain unpaid or at least face substantial repayment difficulties.

Moody’s anticipates the global default rate among speculative-grade companies will reach 5.1% next year, an increase from 3.8% in the 12 months leading up to June. In a worst-case scenario, the default rate could surge to 13.7%, surpassing levels seen during the 2008-2009 financial crisis.

S&P Global predicts that by March 2024, the default rates for speculative-grade companies in the U.S. and Europe will increase from 2.5% and 2.8% respectively in March of this year to 4.25% and 3.6%.

In fact, the factors leading to these debt defaults are not complicated. Bankers and analysts point to high-interest rates as the primary culprit for this predicament; companies requiring additional liquidity must pay higher financing costs, while those with significant historic debts face elevated repayment and refinancing costs.

An even graver concern is that, despite market expectations regarding the closure of the Federal Reserve's current rate-hike cycle, the already elevated interest rates are not expected to decline in the near term, resulting in borrowing costs for companies remaining significantly higher than pre-pandemic levels.

“Capital is now much more expensive,” stated Mohsin Meghji, founding partner of restructuring and consulting firm M3 Partners. In terms of debt costs, companies previously could reasonably obtain debt financing at rates of 4%-6% over the past 15 years, but this has now risen to 9%-13%.

This reality may explain why many businesses are opting to sell off portions of their assets or file for bankruptcy restructuring. Although the high-risk debts due this year are not yet overwhelming, the forthcoming refinancing challenges will only intensify, and early restructuring allows companies more time to confront impending risks.

“The principal debt maturity wall will arise between 2024 and 2026,” stated Navid Mahmoodzadegan, co-founder of independent investment bank Moelis & Co. last month to investors. “Unfortunately, many companies will be unable to refinance before their deadlines. Thus, I believe that not only will many companies face bankruptcy, but there will also be numerous instances of balance sheet restructurings and adjustments in capital structure.”

However, the pressing issue at present is that not all businesses can survive the challenges posed by massive debt, high-interest rates, and inflation. This storm is set to continue.