U.S. Companies Face Mounting Debt Pressure Due to Rising Interest Rates and Possible Recession

Investing with moomoo wrote a column · Jun 27, 2023 03:53

The Bank for International Settlements (BIS) has called for more interest rate hikes recently, warning that the world economy is at a crucial juncture as countries grapple with containing inflation. At the same time, various signs indicate that rising inflation, higher interest rates，and the uncertain economic outlook pressure U.S. companies to refinance and service debt.

U.S. Companies Face Mounting Debt Pressure Due to Rising Interest Rates and Possible Recession

There are growing signals of mounting debt-servicing pressure faced by companies.

1. Rising corporate default rate: Moody's Investors Service has reported that there have been 41 defaults in the U.S. and one in Canada so far this year, recording it as the region with the highest number of defaults globally, with the number more than double the same period last year.

2. Surging issuance of secured bonds: Low-rated companies have to accept tougher financing conditions such as collateral. Recently, 62% of loans taken out by companies have been secured, the highest percentage recorded since 2005.

3. Higher lending cost: Borrowing costs rise with interest rate hikes and decreased risk appetite.

According to Mohsin Meghji, founding partner of M3 Partners: "Capital is much more expensive now. 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%."

4. Shrinking bond maturity: As investors are more concerned about corporate defaults under the possible recession, they prefer bonds with shorter maturity. According to Bloomberg, the average maturity of junk debt has also shrunk to a record low of 5.18 years.

As most Federal Reserve officials expect further interest rate hikes this year to fight inflation, many voices believe that default rates will continue to rise in the next few months. Moody's Investor Services team expects the default rate of speculative-grade corporate to rise to 4.6% at the end of 2023 and peak at 5% by April 2024, higher than the long-term average of 4.1%.

Mark Hootnick of Solomon Partners: "There will be more defaults. 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."

Sharon Ou of Moody: "It's not like one particular sector has had a lot of defaults. Instead, it's quite a number of defaults in different industries. It depends on leverage and liquidity."

Source: Reuters, Bloomberg,WSJ

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Giovanni Ayala : Time to put in more work

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