The current high level of interest rates will increase default rates of leveraged companies. For more than two decades, American companies benefitted significantly from a relatively benign interest rate environment and borrowed extensively via loans and bond issuances. After 11 Federal Reserve hikes in less than a two-year period, numerous companies are feeling the pressures of higher borrowing costs. Even well-known large international companies found it expensive to borrow abroad given high interest rate levels in the United Kingdom and European Union.

The effects of high interest rates are now being seen in the increase of troubled loans and bonds as well as in rising corporate default rates. The data is showing that high interest rates may be pushing U.S. companies into a default cycle. This should be of significant concern to banks that are exposed to leveraged corporates. Bank exposure to very indebted companies comes in multiple forms: lending to these types of companies, investing in their bond and stock issuances, and transacting financial derivatives with them. Rising corporate defaults also pose a challenge for asset managers, banks, insurance companies, pension funds, and university endowments, all of which have been investing in leveraged companies as they chased yield when interest rates were low.

The total of Fitch Ratings’ Top Market Concern Bonds report has now reached $65.5 billion as of Jan. 24, 2024. This is a significant increase of 42% from the December 2023 total of $46.2 billion. The default rate for leveraged loans has increased to 3.4% as of mid-January 2024. This is the second highest level since 2007. The largest leveraged loan default in the last two months was Travelport, LLC, a travel and entertainment company; it had $4.3 billion outstanding in leveraged loans. S&P Global is forecasting default rates for below investment grade bonds to reach 4.75% by the end of 2024.

High interest rates and labor shortages continue to pressure healthcare companies. According to more than 80 healthcare companies filed for bankruptcy in 2023. This was the highest level in the last five years. In just the first month of this year, Fitch Ratings’ data for the top leveraged loans and high yield bonds of concern, show that healthcare companies represent 35% of the outstanding $76.5 billion. Bausch Health Companies
Inc. has more than $15 million in loans and bonds of concern.

If they have not done so already, banks, insurance companies, pension funds and other financial institutions should be increasing their capital and liquidity; this is especially important if they are exposed to sectors such as commercial real estate, healthcare, and telecommunications. Banks can also increase their reserves for rises in nonperforming loans. Regulators also need to ask financial institutions to review how well hedged their portfolios are with credit worthy counterparties. Neither financial institutions nor regulators have a minute to waste in preparing for increasing corporate defaults.

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