Global Courant
Federal Reserve Board Chairman Jerome Powell leaves after addressing a post-Federal Open Market Committee press conference at the Federal Reserve in Washington, DC, on June 14, 2023.
Mandel Ngan | AFP | Getty Images
The Federal Reserve plans to keep raising interest rates to contain inflation, which means corporate defaults are likely to rise in the coming months.
Corporate defaults rose in May, a sign that US companies are grappling with higher interest rates making it more expensive to refinance debt and an uncertain economic outlook.
According to Moody’s Investors Service, there have been 41 defaults in the US and one in Canada so far this year, the most in any region globally and more than double over the same period in 2022.
Earlier this week, Fed Chairman Jerome Powell said he expects more rate hikes this year, albeit at a slower pace, until more progress is made in reducing inflation.
Bankers and analysts say high interest rates are the main culprit. Companies that need more liquidity or are already heavily indebted that need to be refinanced face the high cost of new debt.
The options often include distressed exchanges, which is when a company swaps its debt for another form of debt or buys back the debt. Or, in difficult circumstances, a restructuring can take place in or out of court.
“Capital is much more expensive now,” said Mohsin Meghji, founder of restructuring and consulting firm M3 Partners. “Look at the cost of debt. You could reasonably get an average of 4% to 6% debt financing at any given time over the last 15 years. Now that cost of debt has gone up to 9% to 13%.”
Meghji added that his company has been particularly busy in numerous industries since the fourth quarter. While the most troubled companies have been hit lately, he expects companies with more financial stability to have trouble refinancing due to high interest rates.
According to S&P Global Market Intelligence, there were 324 bankruptcy filings through June 22, not far behind the 2022 total of 374. In April of this year, there were more than 230 bankruptcy filings highest rate for that period since 2010.
The Bed Bath & Beyond logo is on display at the store in Williston, Vermont on June 19, 2023.
Jakub Porzycki | Nurphoto | Getty Images
Envision Healthcare, a provider of emergency medical services, was the largest default in May. According to Moody’s, the company was more than $7 billion in debt when it filed for bankruptcy.
Home security and alarm company Monitronics International, regional financial institution Silicon Valley Bank, retail chain Bed bath & beyond and the owner of regional sports network Diamond Sports are also among the largest bankruptcy filings so far this year, according to S&P Global Market Intelligence.
In many cases, these defaults are months, if not quarters, in the making, said Tero Jänne, co-head of capital transformation and debt advisory at investment bank Solomon Partners.
“The default rate is a lagging indicator of distress,” Jänne said. “Often those defaults only occur after a number of initiatives to address the balance sheet, and it’s only in bankruptcy that you see capital D bankruptcy come into play.”
Moody’s expects the global default rate to rise to 4.6% by the end of the year, higher than the long-term average of 4.1%. That rate is expected to rise to 5% by April 2024 before it begins to ease.
It’s safe to bet there will be more defaults, said Mark Hootnick, also co-head of capital transformation and debt advisory at Solomon Partners. Until now, “we’ve been in an environment of incredibly lax lending where, quite frankly, companies that shouldn’t be tapping into debt markets have been able to do so without restraint.”
This is probably why defaults have occurred in several sectors. There were also some industry-specific reasons.
“It’s not like any particular industry has had a lot of defaults,” said Sharon Ou, vice president and senior credit officer at Moody’s. “Instead, it’s quite a few defaults across industries. It depends on leverage and liquidity.”
In addition to heavy debt, so was Envision overthrown health concerns caused by the pandemic left Bed Bath & Beyond suffering from a large retail footprint while many customers chose to shop online, and Diamond Sports was hurt by the rise of consumers dropping cable TV packages.
“We are all aware of the risks companies are currently facing, such as weakening economic growth, high interest rates and high inflation,” said Ou. “Cyclical sectors, such as consumer discretionary, are affected when people cut spending.”
