By Nicholas Larsen, International Banker
In April, a report published by Moody’s found that 33 of the corporations it rates globally defaulted on their debts during the first quarter of the year—the highest level since the last quarter of 2020, when the global outbreak of the COVID-19 pandemic saw 47 companies default—with 15 in March alone. While the COVID-19 pandemic proved devastating for the solvency of companies worldwide, it now seems that in 2023, the dramatic, ongoing economic slowdown is proving decisive in tipping them over the edge, not only into default but also into bankruptcy. Moreover, the United States leads the world in these unenviable metrics.
As of late June, S&P Global Market Intelligence had counted 324 bankruptcy filings registered by American companies, just 50 fewer than the 374 notched up during all of 2022. And with S&P also recording 236 corporate bankruptcy petitions from January through April of this year—the highest number for these four months since 2010 and more than double the number posted during last year’s January-April period—it has become clear that companies are going bankrupt at a blistering pace in 2023.
This year’s figures have undoubtedly been bolstered by the major banking crises during March, in which S&P recorded a whopping 70 bankruptcy filings. High-profile lenders that defaulted at the time included tech-focused Silicon Valley Bank (SVB) and legal-, real estate- and crypto-oriented Signature Bank, before First Republic Bank joined the list of casualties one month later. And while the ensuing investor panic did much to shake the confidence of the US and global banking sectors, most defaults “continued to reside in non-financial sectors last month”, Moody’s stated in April, citing US sports broadcasting company Diamond Sports Group as the biggest defaulter in pure dollar terms.
Indeed, bankruptcies continued to soar in May, with S&P data revealing a further 54 petitions notched up during the month, while activity peaked during a 48-hour period ending on May 15 in which at least seven large firms filed for Chapter 11 (of the United States Bankruptcy Code) bankruptcy protection, the largest number of filings on record for a two-day period since at least 2008, according to Bloomberg-compiled data on companies with at least $50 million of liabilities.
For the year to the end of May, moreover, consumer discretionary was the sector with the most bankruptcy filings at 37, S&P data revealed. But companies across virtually all sectors have failed to escape this harsh operating environment. “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,” said Sharon Ou, vice president and senior credit officer at Moody’s. “We all know the risks facing companies right now, such as weakening economic growth, high interest rates and high inflation. Cyclical sectors will be affected, such as durable consumers goods, if people cut back on spending.”
This diverse trend has continued to play out, with major US retailers, including Bed Bath & Beyond and David’s Bridal, filing for bankruptcy recently as consumer confidence remained subdued. US communications services have also been hit hard, with advertising revenues across the sector consistently falling throughout the year. The sector’s most notable casualty surfaced on May 15 as one of the seven that filed during the 48-hour frenzy—Vice Media, the renowned journalism stalwart, listed its assets and liabilities in the $500-million-to-$1-billion range in a Chapter 11 filing and has since been sold to creditors, including Fortress Investment Group, Soros Fund Management and Monroe Capital.
Working out what is behind this surge in corporate distress is not a complex matter, either. Higher interest rates are putting immense pressure on companies’ borrowing costs, such that those in need of greater liquidity are having to pay substantially more for financing, while those already burdened with historical debts are now facing higher servicing costs, not to mention the higher amounts required to refinance and restructure existing debts. Indeed, security firm Monitronics, another of the seven companies to succumb during that mid-May 48-hour period, held more than $1 billion of debt maturing in 2024, and it filed for Chapter 11 bankruptcy protection to undertake a restructuring.
“The big themes are that they have degraded in operational quality and have debt that has been unsustainable. That is the formula for bankruptcy in this market,” according to James H. Gellert, chief executive officer of Rapid Ratings International, a company that evaluates the financial health of public and private companies. Gellert spoke to CNN on May 22, noting that many troubled companies have similar traits. Indeed, upon examining the listings, recurring themes among those seeking bankruptcy protection are the excessive levels of debt they racked up when the going was good and rates were low. Today, many of them are feeling the pain of those decisions in a markedly different monetary environment.
It should be observed, however, that at any other time, the elevated borrowing costs for leveraged companies might have been more competently contained. But given the precarious nature of a global economy in which unresolved supply-chain challenges, transportation bottlenecks, sharply rising interest rates and the continuation of the war in Ukraine have sent operating costs soaring, not to mention the declines in incomes that have transpired, many companies face steep uphill battles to remain solvent. It is also worth noting that while bankruptcy does not indicate that a company is in rude health, it does not necessarily equate to the death of that company, either. Filing for such protection offers troubled companies opportunities to improve their balance sheets by restructuring their debts, but it does tend to be more painful for the company’s shareholders.
Nonetheless, the increase in the number of bankruptcy filings being registered this year is clearly not a good sign for the US’ corporate operating environment. It further highlights that the era of easy money that prevailed throughout much of the previous decade amidst an environment of ultra-low interest rates is now little more than a distant memory and that the “unlimited credit party” that was enjoyed for so long is now well and truly over. “Capital is much more expensive now,” Mohsin Meghji, founding partner of restructuring and advisory firm M3 Partners, told CNBC on June 24. “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%.”
With many predicting a recession to materialise in the US later this year, companies, particularly those with weaker balance sheets, could face worsening conditions before things get better. Indeed, S&P Global Ratings Credit Research & Insights sees the US’ trailing-12-month speculative-grade corporate default rate rising from 2.5 percent in March 2023 to 4.25 percent just 12 months later in its base-case projection as rising rates and elevated labour and capital costs erode profitability. Moody’s, meanwhile, predicts the default rate for companies with speculative-grade debt to rise from 2.9 percent to 4.9 percent during the same period, which would easily surpass the long-term average of 4.1 percent.
“Corporates may already be in an earnings recession, growth is expected to slow, while interest rates will likely remain elevated (if unlikely to continue rising or to the same extent as the increases of 2022),” S&P noted in a May 15 report. “Downgrades and defaults resulting from falling cash flow and rising debt costs have increased and affected many sectors. Although inflation continues to fall, the pace of declines appears too slow to warrant a Federal Reserve pivot that markets currently expect. The timing and extent of a potential confluence of rising rates, rising costs, and slowing growth could push the default rate higher still.”
And should a more widespread, deeper or longer downturn transpire, S&P’s worst-case scenario sees the default rate rising to a mighty 6.25 percent. This could become a reality should sticky inflation persist above the Federal Reserve’s 2-percent target over the coming months, forcing additional and/or more aggressive rate hikes to be implemented. “The combination of slower growth, higher unemployment, falling revenue, rising costs, and higher interest rates would be challenging, especially for the historically high proportion of issuers rated ‘B-‘ and ‘CCC’ to ‘C’, many of which are in consumer-facing sectors,” S&P added.