Risky companies are defaulting on loans far faster than high-yield bonds in the wake of the Federal Reserve’s most aggressive credit-tightening campaign in decades.
(Bloomberg) — Risky companies are defaulting on loans far faster than high-yield bonds in the wake of the Federal Reserve’s most aggressive credit-tightening campaign in decades.
The one-year default rate for US loan borrowers has soared to 4%, surpassing the 2.7% pace of delinquency for high-yield bonds by a whopping 1.3 percentage points, according to an analysis by Morgan Stanley. It’s the first time in 30 years that the clip of loan defaults led junk bonds by such a margin.
“The higher cost of debt is flowing through immediately for loan borrowers,” Amanda Lynam, head of macro credit research at BlackRock Inc., said Tuesday on Bloomberg Television. “But it’s taking some time for the high-yield bond universe.”
A pickup in defaults among risky firms comes as US policymakers sent borrowing costs soaring in a bid to combat sticky inflation. That’s had an impact on loan borrowers, who’ve seen interest costs rise on the floating-rate debt alongside central bank rate hikes.
The leveraged loan market also tends to lure smaller and lower-rated issuers, as well as private equity-backed companies, which accounted for around 60% of the universe through June 30, according to data from PitchBook LCD.
Distressed exchanges have become a more-popular tool among private equity firms seeking to restructure debt for portfolio companies, according to Morgan Stanley strategists led by Vishwas Patkar. That, and a deterioration in the covenants that govern loans, have contributed to the uptick in defaults, they wrote in an Aug. 11 note.
Focus now shifts toward the Fed, with the debate heating up among officials over how long interest rates should stay elevated. Economists are increasingly optimistic on the odds of a so-called soft landing in the US, helping to ease anxiety about a more-dramatic wave of delinquency.
Moody’s Investors Service now forecasts the global speculative-grade default rate to peak at 4.7% in March, below previous expectations for a 5.1% apex. The rate will likely ease to 4.3% by next July — though a modest economic slowdown will drag on the ability of lower-rated companies to refinance their debt and maintain cash flows, according to the credit assessor.
For BlackRock’s Lyman, however, there’s still a latent risk for junk bond investors as maturities approach and force borrowers back into the market at higher costs.
“High-yield borrowers by and large have the luxury of being patient at the moment,” she said. “They’ve done so much refinancing, so much proactive liquidity raising in 2020 and 2021 that they don’t need to act just yet. They can still be patient, but it’s only a matter of time before we get closer to that maturity wall.”
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