High interest rates drive U.S. junk bond defaults to a four

High Interest Rates Loom: Global High-Risk Companies Facing Default Surge

As the Federal Reserve maintains its high interest rate policy, borrowing costs for global high-risk companies have risen sharply, leading to increasing corporate default rates. According to the latest report from Moody's, the global leveraged loan default rate rose to 7.2% in the 12 months ending October 2023, the highest level since 2020. Moody's noted that this rising trend is primarily due to the pressure of the high interest rate environment on heavily indebted companies.

The "Aftereffects" of Post-Pandemic Low Interest Prosperity

After the outbreak of the COVID-19 pandemic, the Federal Reserve slashed borrowing costs to near zero through emergency rate cuts, spurring corporate borrowing, especially among "junk-rated" companies, leading to a boom in leveraged loan issuance. At the time, these floating rate loans were favored due to their low costs. However, as the Fed's rate-hiking cycle continues, these companies face sharply increased financing costs, plunging many into financial distress.

David Mechlin, Credit Portfolio Manager at UBS Asset Management, stated: "A large volume of bonds were issued in the low-interest environment, and the pressure of high interest rates is gradually becoming apparent over time. This default trend may persist until 2025."

Responding to Defaults: Debt-for-Equity Swaps and Discounted Buybacks Prevail

In the face of heavy debt and potential bankruptcy protection, many companies have opted for debt restructuring. For example, they are avoiding bankruptcy through debt-for-equity swaps or discounted debt buybacks. According to Ruth Yang, Head of Private Markets and Alternatives at S&P Global Ratings, such transactions account for over half of all default deals this year, setting a new record.

Structural Changes in the Leveraged Loan Market

Long-term changes in the leveraged loan market are also contributing to the rise in default rates. Mike Scott, a Senior High Yield Fund Manager at Man Group, pointed out that many new borrowers in the market come from the healthcare and software sectors, where companies generally have lighter assets, resulting in lower recovery rates for investors in the event of a default. He believes: "The leveraged loan market has experienced a decade of unchecked growth."

Despite the rising default rates, the credit spread of U.S. junk bonds remains at historically low levels. According to Bank of America data, the spread is at its lowest since the 2007 financial crisis, indicating strong investor demand for high-yield bonds.

Rate Cuts May Be a Turning Point, but Short-Term Risks Persist

Some analysts believe that a gradual rate-cutting cycle by the Federal Reserve may ease current pressures. Brian Barnhurst, Global Head of Credit Research at PGIM, suggests that as borrowing costs decrease, companies that previously issued junk bonds might find some relief.

However, Barnhurst also noted that the relationship between leveraged loan and high-yield bond default rates has changed, and they no longer rise in tandem. He suggests that the current surge in default rates may be a temporary phenomenon, but market uncertainty remains in the future.

Overall, high interest rates are accelerating the trend of corporate defaults. Although investor demand for high-risk assets does not appear to have significantly decreased, companies and financial markets must remain vigilant against potential systemic risks.

The market carries risks, and investment should be cautious. This article does not constitute personal investment advice and has not taken into account individual users' specific investment goals, financial situations, or needs. Users should consider whether any opinions, viewpoints, or conclusions in this article are suitable for their particular circumstances. Investing based on this is at one's own responsibility.

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