A $500 billion corporate debt storm is brewing over the global economy, generating bankruptcies and unemployment, writes Bloomberg, reminding us that the era of easy money is over.
A $500 billion corporate debt storm is brewing over the global economy
Richard Cooper, a partner at a leading corporate bankruptcy law firm, has advised companies around the world for decades on what to do when they are drowning in debt, writes Bloomberg, recalling his predictions from the global financial crisis, the 2016 oil crisis and Covid-19. And it’s doing it again now, in a year in which major corporate bankruptcies are piling up at the second-fastest pace since 2008, eclipsed only by the early days of the pandemic.
“It feels different than previous cycles,” Cooper said. “You’re going to see a lot of defaults.”
His position and access to financial information have given him a preview of the $500 billion-plus storm, a corporate debt crisis that is already starting to hit the ground running around the globe, according to data compiled by Bloomberg. The number is almost certain to increase. And that adds to concerns on Wall Street by threatening to slow economic growth and strain credit markets that are just emerging from their worst losses in decades.
On the surface, much of the storm looks like the usual turmoil of capitalism, of companies undermined by forces like technological change or the rise of remote work that has emptied office buildings in Hong Kong, London and San Francisco.
The era of unusually cheap money is over
However, there is often a deeper and more troubling line underneath: debt that has grown during an era of unusually cheap money. Now that’s becoming a heavier burden as central banks raise interest rates and look poised to keep them there longer than almost everyone on Wall Street expected.
The rising tide of danger is, of course, to some degree by design. Caught by surprise while inflation soared, monetary policymakers aggressively drained cash from the global financial system, intentionally trying to slow their economies by stopping the flow of credit to businesses. Inevitably, that means some will fail.
But pockets of corporate credit look particularly vulnerable after booming in the years of very low interest rates, when even ailing companies could easily borrow to delay the reckoning.
In the US, the value of high-yield bonds and boomerang loans – which are owed by riskier and less solvent businesses – has more than doubled since 2008 to $3 trillion in 2021, before the Federal Reserve to begin the steepest rate hikes in a generation, according to data from S&P Global.
During the same period, the debt of Chinese non-financial companies grew relative to the size of the nation’s economy. And in Europe, junk bond sales are up more than 40% in 2021 alone. Many of these bonds will have to be repaid in the next few years, contributing to a wall of $785 billion in debt due to mature.
With economic growth cooling in China and Europe — and the Fed expected to continue raising rates — those repayments could be too much for some companies to bear. In America alone, the stock of bad bonds and loans has already grown more than 360% since 2021, the data shows. If it continues to spread, this could lead to the first broad default cycle since the Great Financial Crisis.
“It’s like an elastic band,” says Carla Matthews, who heads the insolvency and asset recovery department at UK consultancy PwC. “You can get rid of some tension. But there will be a moment when it will break.”
120 major bankruptcies in the US this year alone
This is already starting to happen, with over 120 major bankruptcies in the US alone this year. Even so, less than 15 percent of the nearly $600 billion in distressed debt trading globally has defaulted, the data show. That means companies that owe more than half a trillion dollars may be unable to pay it back — or at least struggle to do so.
This week, Moody’s Investors Service said the default rate for speculative-grade companies worldwide is expected to reach 5.1 percent next year, up from 3.8 percent in the 12 months to June. In the most pessimistic scenario, it could rise to 13.7% – surpassing the level reached during the credit collapse of 2008-2009.
Of course, much remains uncertain. The US economy has remained surprisingly resilient in the face of higher borrowing costs, and the steady slowdown in inflation is raising speculation that the Fed could steer the economy toward a soft landing. Yield spreads on the US junk bond market – a key measure of perceived risk – have also narrowed since March, when the collapse of Silicon Valley Bank briefly sowed fears of a credit crunch that never materialized.
Vicious chain: Bankruptcies generate unemployment and implicitly decrease consumption
However, even a relatively modest increase in the default value would add another challenge to the economy. The more defaults rise, the more investors and banks can pull back on loans, in turn pushing more companies into trouble as financing options disappear. The resulting bankruptcies would also put pressure on the labor market as workers are laid off, with a corresponding dent in consumer spending.
“You’re going to see situations — for example, in the retail sector — where the business just doesn’t make sense, and no amount of balance sheet repair is going to cure a particular borrower’s ailments,” Cleary Gottlieb’s Cooper said.
The post-pandemic reality. But not only the pandemic is to blame
In London’s Canary Wharf, the name HSBC is inscribed on top of the 45-storey office tower that has been its headquarters for two decades. It is one of a constellation of big banks that have transformed East London’s once abandoned riverside into a global financial centre.
Even before the pandemic, banks have been quietly reducing office space in London, reflecting both cost-cutting and Britain’s exit from the European Union. Remote work accelerated it.
This fell particularly hard on Canary Wharf. Two buildings owned by Chinese property developer Cheung Kei Group have been taken into receivership after defaulting on loans. More bad news came in June: HSBC said it planned to leave by the end of 2026. This is another blow to Canary Wharf Group, the developer whose credit rating has already been deeply cut as rates job vacancies are rising and retailers are struggling. It has more than £1.4 billion (about $1.8 billion) in debt due in 2024 and 2025.
More than a quarter of the debts come from real estate. Most from China
No other industry is under as acute pressure as commercial real estate from the slow return to offices that have emptied buildings and thinned downtowns. More than a quarter of global distressed debt — or about $168 billion — is tied to the real estate sector, more than any other group, the data show.
There seems to be little relief on the horizon. A survey by real estate consultant Knight Frank found that half of the international firms surveyed plan to downsize office space. Convincing tenants to come back can be expensive, especially as businesses look for greener workspaces.
“Tenants have bargaining power now,” said Euan Gatfield, managing director at Fitch Ratings.
Most of the distressed debt related to the real estate sector is the result of China’s housing crisis. As China Evergrande Group restructures its debt, major companies such as Dalian Wanda Group Co. and Country Garden Holdings Co. they saw their debt prices fall. In the US, coworking giant WeWork Inc., whose losses have piled up since its 2020 IPO, has bonds maturing in 2025 currently yielding around 70%.
As demand for office space falls, Canary Wharf Group is trying to reduce the district’s reliance on the financial industry, with plans to attract life sciences companies and build more housing. Investors have doubts: One of the company’s bonds, which matures in 2028, is trading at about 68% of its face value. Canary Wharf and the other companies declined to comment.
Big companies buy the small ones
Private equity firms thrived on easy loans thanks to a simple recipe: Find a company to buy, borrow money from Wall Street, then cut costs to make a profit. This often left those companies deeply in debt, often with variable rate loans.
It mattered little when the Fed pegged interest rates near zero, and some buyout firms seemed to see little risk that rates would rise — opting not to buy even the relatively low-cost hedges that would protect their companies. Now, interest rates are now rising on those variable rate loans, pushing many of those businesses to the brink.
More than $70 billion of debt from private equity companies is trading at distressed levels. Shutterfly LLC, the online photo printing company, is one of them.
Apollo Global Management bought Shutterfly about four years ago for about $2.7 billion, much of it financed with debt. When it refinanced in 2021, the interest rate on its roughly $1 billion term loan was only about 5 percent. At the time, Moody’s expected the debt to become more manageable as the business improved.
That didn’t happen. Instead, Shutterfly burned through cash as inflation squeezed consumers and businesses.
Meanwhile, the lending rate has jumped to around 10% this year. With the company’s financial outlook darkening, its creditors have agreed to swap the loan for new bonds that will take its debt bills out. Moody’s said the deal was akin to a default and rated the new debt junk. Apollo did not respond to requests for comment about Shutterfly. Shutterfly declined to comment.
High bills squeeze family budgets
Rising rates are a double threat to consumer spending companies as higher bills squeeze household budgets.
Advertising is among the first expenses that companies cut when preparing for a recession, and that could come down to the likes of Audacy Inc. One of the largest owners of radio stations in the US, Audacy is more than $800 million in debt next year.
In May, S&P cut the company’s rating further, predicting it will be forced to restructure its debt as the economy slows. Audacy said it is currently in discussions with lenders about refinancing options.
2023-07-19 10:46:21
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