High interest rates and economic uncertainty are behind recent rise in corporate defaults

The
Federal
Reserve

plans
to
keep
hiking
interest
rates
to
stem
inflation,
which
means
an
increase
in
corporate
default
rates
is
likely
in
coming
months.

The
corporate
default
rate
rose
in
May,
a
sign
that
U.S.
companies
are
grappling
with
higher
interest
rates
that
make
it
more
expensive
to
refinance
debt
as
well
as
an
uncertain
economic
outlook.

There
have
been
41
defaults
in
the
U.S.
and
one
in
Canada
so
far
this
year,
the
most
in
any
region
globally
and
more
than
double
the
same
period
in
2022,
according
to
Moody’s
Investors
Service.

Earlier
this
week,
Fed
Chairman
Jerome
Powell
said
to
expect
more

interest
rate
increases
this
year,
albeit
at
a
slower
rate,
until
more
progress
is
made
on
lowering
inflation.

Bankers
and
analysts
say
high
interest
rates
are
the
biggest
culprit
of
distress.
Companies
that
are
either
in
need
of
more
liquidity
or
those
that
already
have
hefty
debt
loads
in
need
of
refinancing
are
faced
with
a
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
repurchases
the
debt.
Or,
in
dire
circumstances,
a
restructuring
may
take
place
in
or
out
of
court.

“Capital
is
much
more
expensive
now,”
said
Mohsin
Meghji,
founding
partner
of
restructuring
and
advisory
firm
M3
Partners.
“Look
at
the
cost
of
debt.
You
could
reasonably
get
debt
financing
for
4%
to
6%
at
any
point
on
average
over
the
last
15
years.
Now
that
cost
of
debt
has
gone
up
to
9%
to
13%.”

Meghji
added
that
his
firm
has
been
particularly
busy
since
the
fourth
quarter
across
numerous
industries.
While
the
most
troubled
companies
have
been
affected
recently,
he
expects
companies
with
more
financial
stability
to
have
issues
refinancing
due
to
high
interest
rates.

Through
June
22,
there
were
324
bankruptcy
filings,
not
far
behind
the
total
of
374
in
2022,
according
to
S&P
Global
Market
Intelligence.
There
were
more
than
230
bankruptcy
filings
through
April
of
this
year,
the

highest
rate
for
that
period
since
2010.

Envision
Healthcare,
a
provider
of
emergency
medical
services,
was
the
biggest
default
in
May.
It
had
more
than
$7
billion
in
debt
when
it
filed
for
bankruptcy,
according
to
Moody’s.

Home
security
and
alarm
company
Monitronics
International,
regional
financial
institution
Silicon
Valley
Bank,
retail
chain


Bed
Bath
&
Beyond
and
regional
sports
network
owner
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.
“A
lot
of
times
those
defaults
don’t
occur
until
well
past
a
number
of
initiatives
to
address
the
balance
sheet,
and
it’s
not
until
a
bankruptcy
you
see
that
capital
D
default
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
projected
to
rise
to
5%
by
April
2024
before
beginning
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
credit,
where,
frankly,
companies
that
shouldn’t
be
tapping
the
debt
markets
have
been
able
to
do
so
without
limitations.”

This
is
likely
why
defaults
have
occurred
across
various
industries.
There
were
some
industry-specific
reasons,
too.

“It’s
not
like
one
particular
sector
has
had
a
lot
of
defaults,”
said
Sharon
Ou,
vice
president
and
senior
credit
officer
at
Moody’s.
“Instead
it’s
quite
a
number
of
defaults
in
different
industries.
It
depends
on
leverage
and
liquidity.”

In
addition
to
big
debt
loads,
Envision
was

toppled
by
health-care
issues
stemming
from
the
pandemic,
Bed
Bath
&
Beyond

suffered
from
having
a
large
store
footprint
while
many
customers
opted
for
shopping
online,
and
Diamond
Sports
was

hurt
by
the
rise
of
consumers
dropping
cable
TV
packages.

“We
all
know
the
risks
facing
companies
right
now,
such
as
weakening
economic
growth,
high
interest
rates
and
high
inflation,”
Ou
said.
“Cyclical
sectors
will
be
affected,
such
as
durable
consumers
goods,
if
people
cut
back
on
spending.”