The current high level of interest rates will increase default rates of leveraged companies. For over two decades, American companies benefitted significantly from a relatively benign interest rate environment and borrowed extensively via loans and bond issuances. After eleven Federal Reserve hikes in less than a two-year period, numerous companies are feeling the pressures of higher borrower 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.
We are now seeing the effects of high interest rates 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. The total of Fitch Ratings’ Top Market Concern Bonds has now reached $65.5 as of January, 24, 2024; this is a significant increase of 42% from the December 2023 total of $46.2 billion.
High interest rates and labor shortages, especially, continue to pressure healthcare companies. According to BankruptcyData.com, over 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, of Fitch Ratings’ top leveraged loans and high yield bonds of concern, healthcare companies represent 35% of the outstanding $76.5 million. Bausch Health Companies Inc. has over $15 million in loans and bonds of concern.
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 travel and entertainment company, Travelport, LLC; it had $4.3 billion outstanding in leveraged loans.
S&P is forecasting default rates for below investment grade bonds to reach 4.75% by the end of 2024.
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 non-performing 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.