The probability of default increases for high-yield bonds and leveraged loans

And in another sign that the US economy is heading for a hard landing, the probability of leveraged loans and high-yield bonds to default and actual defaults continues to rise. Market signals, as well as rating analysts and my research suggest that the default rate is around 2% or higher from 2023 to 2024.

As I wrote about it nearly a decade ago, American companies were devouring themselves into the debt pool. Until recently, banking regulators from the Comptroller’s Office had indicated that they would not impose any enforcement action against banks that had lent too much to leveraged companies. This regulatory tone, combined with the low interest rate environment, has enabled companies to reach historical levels of indebtedness.

Now, however, the days of low interest rates have changed dramatically. If there was inflation only in the US, then leveraged US companies might be able to handle the pressure, but inflation is global. The interest rate hikes by many of the major central banks around the world have not been able to eliminate the significant inflationary pressures that have arisen, especially due to the supply chain issues caused by the Covid virus. Thus, American firms are faced with rising prices for many inputs from all over the world. Moreover, the rising dollar means that US exporters’ goods and services are increasingly becoming more expensive consumers and businesses in many foreign countries.

“There are quite a few companies that could default during Q422 and push the rate down to 2%,” explained Eric Rosenthal, senior director of finance at FitchRatings. For example, “Ligado Networks LLC, the third largest issuer in Top Market Worry Bonds The list, is an attempt at a very sad level.”

US high-yield Fitch forecast for September default It shows that the high US year-to-date (YTD) default rate could rise to 1.7% from the current 0.8%, depending on Bausch Health’s final amount.
BHC
(Default Debt Exchange (DDE) issuer default rating of C). “The drug company announced early exchange results totaling $5.6 billion of a potential $11.8 billion that would put the year-to-date default rate at 1.2%.” If the exchange takes place (the closing date is tomorrow September 27), “My Bausch default will represent the largest since Frontier Communications Inc. in April 2020”.

Diebold Nixdorf Inc. is and Cooper-Standard Automotive Inc. and Ahern Rentals Inc. (which canceled the DDE) and Lannett Co. Inc. and Mountain Province Diamonds Inc. Other issuers at FitchRatings top market The list could be in default before the end of 2022. Rosenthal also stated that “Avaya
AVYA
Inc. and Bed, Bath & Beyond Inc. They are other large issuers that we expect to default in 2023 but may default earlier. "

Currently, retail, telecom and broadcast/media are likely to drive the default rate in 2023 - 2024. According to Rosenthal, “the default rate in these sectors is rising because of the defaults already expected rather than because of sector concerns.” FitchRatings analysts believe these segments could “make up more than half of the hypothetical volume for the coming year, with these segments reaching rates of around 10%.

As Lee Rosenthal wrote, “The world of high-yield bonds continues to shrink (11 .).^{The tenth} respectively) due to lack of issuance and rising stars exiting the market.” The issuance was lackluster and contributed to the decline, with five consecutive months of volume under $10 billion. The $38.9 billion outflows from mutual funds to date have led to The side of the average secondary bid levels at 87.0, to hamper market activity.”

It should also be of concern to investors and regulators that the riskiest loans in the leveraged loan markets, rated B, now account for nearly a third of the entire market. This is a strong market signal that the probability of default in these companies is rising. This is the first time there has been such a high level of B loans in the 25-year history of the Morningstar LSTA Index of US Leverage Loans.

Financial institution risk managers should not be complacent about the state of the high-yield and leveraged loan markets. To be sure, banks are not immune to the deterioration of the leveraged loan market. American bank
buck
CreditSuisse and Goldman Sachs lost more than $500 million in a leveraged loan that was underwritten to support the purchase of Citrix Systems
CTXS
The largest purchase of US financial debt this year. The loan was sold to investors at a discount of 16%.

Higher interest rates in many countries will negatively affect leveraged companies with floating interest rate loans or bonds. London Interbank Offered Rates (LIBOR) are at their highest since 2008, and other floating rates are on the rise. This means that companies with variable liabilities or that have to refinance this year and next are exposed to higher borrowing costs and potentially defaults. Unfortunately, no relief looms for US companies.

Note: Rodríguez Valladares has published over 40 articles on leveraged financing markets, corporate debt, and secured loan obligations. It can be found here.