Long-feared corporate debt woes start to hit home

The spectre of rising corporate debt defaults exacerbating a global economic slowdown has for months been largely brushed aside by resilient credit markets.

Now, long-feared corporate debt woes are starting to hit home, while more companies are being downgraded to a junk credit rating – facing higher borrowing costs as a result.

Retailer Casino, with 6.4 billion euros ($7.19 billion) of net debt, is in court-backed talks with creditors; Britain’s Thames Water is in the headlines with its 14 billion pound ($18.32 billion) debt pile.

Swedish landlord SBB (SBBb.ST), downgraded to junk in May, is at the epicentre of a property crash that threatens to engulf Sweden’s economy.

Yet the cost of insuring exposure to a basket of European junk-rated corporates last week briefly hit its lowest in just over a year, suggesting investors remain unperturbed by rising default risks.

“You have a lot of complacency in the market, if you think that statistics show that we have had already as many defaults globally in the first five months of 2023 as in the whole 2022,” said Julius Baer’s head of fixed income research Markus Allenspach.

“But there are still inflows into high yields (bonds),” he said.

S&P Global expects default rates for US and European sub-investment grade companies to rise to 4.25 per cent and 3.6 per cent respectively by March 2024, from 2.5 per cent and 2.8 per cent this March.

Hopes the world economy will avoid a sharp downturn and that aggressive rate hikes will soon end explain the upbeat sentiment.

But analysts note the impact of rate rises has yet to be fully felt.

For some, this means corporate bond yields should command a higher premium. The current spread on the ICE BofA global high yield bond index is at 435 basis points (bps), down from 622 bps a year ago. (.MERHW00)

“Corporate credit spreads are still extremely tight and are not reflecting the risks that are out there,” said Guy Miller, chief market strategist at Zurich Insurance Group.

Miller said 122 US public and private companies with liabilities over $50 million have already filed for bankruptcy protection so far this year, implying a run rate that will cause bankruptcies to exceed 200 by year-end – comparable to that seen during the global financial crisis and COVID-19.

While some firms took advantage of the low rates era to extend the maturity of their debt, buying themselves some time, refinancing will be costly for those with looming debt maturities.

“On aggregate, things don’t look dreadful. But it’s not the aggregate you worry about, it’s the marginal players coming through that now are having to pay massively more to borrow,” Miller said.

ABN AMRO said the average maturity of European high yield corporate bonds reached a record low of almost four years in May, versus an average of just over six years between 2005-2007, when the European Central Bank also jacked up rates.

That means firms have less time than previously to refinance debt, so the pain of higher rates will be felt sooner.

RESTRUCTURING

Failing to pay higher interest costs or to refinance maturing debt are among the main reasons companies default.

To avoid having to repay their debt immediately following a default, or finding themselves insolvent, firms are starting talks with creditors on how to restructure their debt and turn their business around.

Take cash-strapped Casino. Plagued by hefty debt following a string of acquisitions and dwindling earnings, the company is seeking at least 900 million euros of new capital to stay afloat, while slashing its debt pile.

Still, debt restructuring experts said the legal systems in place have evolved since the financial crisis, so a disorderly wind-up of businesses can mostly be avoided.

In Spain, the effectiveness of a new restructuring law is being tested as a restructuring plan for industrial group Celsa goes through the courts.

“The outcome of restructuring processes is now more predictable than 10 years ago, as the legal frameworks across European countries have become more aligned,” said Aymen Mahmoud, co-head of the London Finance, Restructuring and Special Situations Group at law firm McDermott Will & Emery.

Nonetheless, not all firms may be able to survive the challenges of vast debt, higher interest and business costs and declining profits.

“We are still some 12 months away from seeing the full impact, particularly in Europe, where the downturn may be less severe, but recovery will also be slower,” said Elena Lieskovska, partner at Bain Capital Special Situations.