The probability of default increases for high-yield bonds and leveraged loans

Another sign that the US economy is headed for a hard landing is that leveraged and high yield default rates and actual defaults continue to rise. Market signals and research by rating analysts and myself point to a default rate of around 2% or even higher for 2023-2024.

As I’ve written for almost a decade, American companies are eating into debt troughs. Until recently, the Office of the Comptroller’s banking regulators indicated that they would take no enforcement action against banks that overborrowed from leveraged companies. This regulatory tone, coupled with a low interest rate environment, also allowed companies to reach historic levels of debt.

Now, however, the times of low interest rates have changed significantly. If only US inflation existed, heavily leveraged American companies could handle the pressure, but inflation is global. Rising interest rates from several major central banks around the world have failed to quell the significant inflationary pressures that have arisen, in particular, from Covid-induced supply chain issues. As a result, American companies are faced with rising prices of many inputs from around the world. In addition, a stronger dollar means that American exporters’ goods and services are becoming increasingly expensive for consumers and businesses in numerous other countries.

Eric Rosenthal, FitchRatings’ senior director of leveraged finance, stated that “there are a handful of companies that could default in Q4’22 and push the rate to 2%.” For example, “Ligado Networks LLC, the third largest issuer on our Top market concern bonds List, is bid at a severely distressed level.”

Fitch US High Yield Default Insight, September shows that the year-to-date (YTD) default rate of US high-yield bonds could increase from the current 0.8% to as high as 1.7%, depending on the final height of the Bausch Health CompaniesBHC
Inc. (Issuer Default Rating C) Distressed Debt Exchange (DDE). “The pharmaceutical company announced results of the early exchange offer totaling $5.6 billion from a potential $11.8 billion, which would bring the YTD delinquency rate to 1.2%.” If the exchange goes through ( closing date is tomorrow, September 27), “Bausch’s outage would represent the largest since Frontier Communications Inc. in April 2020.”