DISTRESSED CORPORATE DEBT RISES. WILL A DEFAULT WAVE FOLLOW?

The number of corporations with bonded debt regarded as “distressed”—a sign that the companies are moving toward default—is the largest since September 2020.

“Distressed” is defined as bonds trading at least 10 percentage points above the yield on the 10-year treasury note or trading at less than 80 percent of face value.

After growing for five consecutive weeks, distressed corporate issues reached a value of $271.3 billion last week, according to Bloomberg.

Interest rates have been low for years and crashed nearly to zero in early 2020 as the U.S. Federal Reserve slashed them to keep the economy functioning during COVID lockdowns.

As a result, companies—including many with questionable prospects and credit ratings—binged on debt. Now those same companies face the prospect of refinancing their debt at interest rates more than 12 times higher than they previously were paying.

“You’re going to see a lot more distressed companies borrowing at a much higher rate,” Jordana Renert, a lawyer at Lowenstein Sandler specializing in corporate restructuring, told Bloomberg, leading to “an uptick in the bankruptcy cycle.”

One candidate: cruise line Carnival Corp., which is toting $8 billion in distressed bonded debt. It recently managed to sell another $2 billion worth of bonds to refinance other bonds, but had to promise buyers a 10.75-percent return. 

Last year, Carnival could sell bonds with a 6-percent yield.

The corporate default rate could double to 3 percent from its present 1.5 percent, Jonathan Lavine, co-managing partner at Bain Capital, said in a 27 October Bloomberg interview.

Among companies with at least $50 million in bonded debt, 75 have filed bankruptcy this year, compared with 100 last year to date and 200 in 2020 as the COVID War was raging.

However, the current pace will grow, predicted Stacy Tecklin, who heads the distressed debt practice at law firm Glenn Agre.

“We’re seeing a lot of behind-the-scenes restructuring talks to avoid the bankruptcy process,” she told Bloomberg, then added, “winter is coming.” 

TRENDPOST: Financial markets see a difference between distressed debt, which is rated at CCC or below, and junk bonds, which carry ratings of BBB or less.

In practical terms, there will be no difference as corporate costs rise along with interest rates and the economy sinks deeper: more companies with distressed debt and junk bonds will default and the number filing for bankruptcy will increase, especially during the first quarter of 2023.

TREND FORECAST: We said it in “Will Junk Bonds Turn to Junk?” (14 Sep 2021) and “Value of Corporate Bonds Ranked as ‘Junk’ Doubles in 2022” (10 May 2022): junk bonds and weak and overleveraged corporations were in trouble as soon as the Fed laid out a timetable last winter for ending its bond-buying spree and raising interest rates.

Now that the Fed has done both, the number and pace of defaults will accelerate.  

Among the most overleveraged companies, at least 4 percent will disappear, be bought for cheap by competitors or Bigs, or survive through the Chapter 11 bankruptcy courts.