Tides of corporate debt slowly rising – Report

Concerns over the potential for large-scale corporate debt defaults worldwide have been muted or simply brushed aside by credit markers, Reuters reported Tuesday.

But long-feared corporate debt woes are only just starting to materialize, and any such debt defaults can further disrupt already slowing global economies.

Meanwhile, more companies are being downgraded to lower credit ratings, facing higher borrowing costs as a result, the news agency reported.

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

Meanwhile, Swedish landlord SBB, downgraded to “junk” credit rating in May, as reported by Reuters, is at the epicentre of a property crash that threatens to engulf Sweden’s economy.

When interest rates are higher, borrowing costs rise, affecting companies’ ability to access financing – Source: Shutterstock

Yet the cost of insuring exposure to a basket of European junk-rated corporates last week reportedly hit its lowest in just over a year.

If anything, this suggests that investors remain unmoved 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 told Reuters.

S&P Global expects default rates for United States (US) and European sub-investment grade companies to rise to 4.25 percent and 3.6 percent respectively by March 2024. Up from 2.5 percent and 2.8 percent this March.

Apparently, economists and investors are hoping the world economy will avoid a sharp downturn and that aggressive rate hikes will soon end.

Otherwise, where is this hope coming from?

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

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

Miller said 122 US public and private companies with liabilities over $50 million have already filed for bankruptcy protection so far this year. This implies 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.

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

Statues in a square on Wall Street are seen in the picture – Source: Shutterstock

“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, compared to an average of just over six years ago, 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 corporate debt

Inability to pay higher interest costs or refinance maturing debt are among the top reasons why companies default.

What companies do, to avoid having to repay their debt immediately after a default or become insolvent, firms are engaging creditors on restructuring their debt to turn their business around.

For example, cash-strapped Casino are plagued by hefty debt following a string of acquisitions and dwindling earnings. The company is seeking at least $1.01 billion 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, according to Reuters.

In Spain, the 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,” Aymen Mahmoud said.

He is 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.

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