The Rising Concern of Surging Corporate Debt and Impending Defaults

Richard Cooper, a partner at Cleary Gottlieb, one of the leading corporate bankruptcy law firms, has advised companies around the world for decades on what to do when they are drowning in debt.

It did so during the global financial crisis, the 2016 oil crash, and COVID-19. And he’s doing it again now, in a year in which big business bankruptcies are piling up at the second-fastest pace since 2008, dwarfed 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 has given him a foretaste of the storm of more than $500 billion of corporate debt that is already beginning to make landfall around the world, according to data compiled by Bloomberg. It is almost certain that the account will grow.

And that is raising concerns on Wall Street by threatening to slow economic growth and tighten credit markets that have just emerged from the deepest losses in decades.

On the surface, much of it looks like the usual turmoil of capitalism, of businesses being undermined by forces like technological change or the rise of remote work that has emptied office buildings in Hong Kong, London and San Francisco.

Beneath it, however, often lies a deeper and more worrisome line: debt loads that have increased during an era of unusually cheap money. Now, that’s becoming a heavier burden as central banks raise interest rates and seem willing to keep them there longer than almost everyone on Wall Street expected.

The rising tide of angst is, of course, to some degree by design. Caught off guard by rising inflation, policymakers have been aggressively draining cash from the global financial system, intentionally seeking to slow their economies by blocking the flow of credit to businesses. Inevitably, that means some will fail.

But corporate credit pockets look particularly vulnerable after soaring during the years of rock-bottom interest rates, when even faltering companies could easily borrow to delay reckoning.

In the US, the number of high-yield bonds and leveraged loans, which are owed by riskier and less creditworthy companies, more than doubled from 2008 to $3 billion in 2021, before the Federal Reserve began its biggest rate hikes. pronounced in a generation, according to S&P Global data.

During the same period, the debts of Chinese non-financial companies increased relative to the size of that nation’s economy. And in Europe, junk bond sales are up more than 40 percent in 2021 alone. Many of those securities will need to be paid off in the coming years, contributing to a $785 billion wall of maturing debt.

With growth cooling in China and Europe, and the expectation that the Fed will continue to raise rates, those refunds may be too much for some companies. In America alone, the pile of troubled bonds and loans has already risen more than 360 percent since 2021, data shows. If it continues to spread, that could lead to the first widespread cycle of defaults since the Great Financial Crisis.

“It’s like a rubber band,” says Carla Matthews, head of contentious insolvency and asset recovery at UK consultancy PwC. “You can get away with a certain amount of tension. But there will be a point where it breaks.”

That’s already starting to happen, with more than 120 major bankruptcies in the US alone this year. Even so, less than 15 percent of the nearly $600 billion in debt trading at distress levels around the world has defaulted, the data shows. That means companies that owe more than half a trillion dollars may not be able to pay it, or at least have a hard time paying it.

This week, Moody’s Investors Service said the default rate for speculative-grade companies worldwide is expected to hit 5.1 percent next year, up from 3.8 percent in the 12 months ending in June. In the worst-case scenario, it could rise as high as 13.7 percent, surpassing the level reached during the 2008-2009 credit crunch.

The US economy, for example, has remained surprisingly resilient in the face of higher borrowing costs, and the steady slowdown in inflation is fueling speculation that the Federal Reserve may be steering the economy toward a soft landing.

Yield spreads in the US junk bond market, a key measure of perceived risk, have also narrowed since March, when the collapse of Silicon Valley Bank briefly raised fears of a credit crunch that never materialized.

However, even a relatively modest increase in defaults would add another challenge to the economy. The more defaults rise, the more investors and banks can withdraw loans, which in turn pushes more companies into distress as financing options disappear. The resulting bankruptcies would also put pressure on the labor market as employees are laid off, with a corresponding drag on consumer spending.

2023-07-19 00:45:22
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