Get ready for corporate default rates to climb
Default rates in the U.S. corporate bond market hit all-time lows near zero last year — but they’re starting to tick back up.
Why it matters: With recession worries hitting a fever pitch, the question isn’t whether defaults will rise — it’s how high they’ll go, and how much damage that'll inflict on investors.
State of play: KBRA Analytics forecasts that the high-yield bond default rate a year from now will be around 3.76%.
- That’s up from 0.40% now — and would surpass the historical mean of 3.61%.
What they're saying: "We are in a post-COVID world, and everything is kind of going back to normal," Van Hesser, KBRA's chief strategist, tells Axios. "Now the question is: what follows?"
- Already, the capital markets have all but cut off the lowest-quality issuers, the ones with "CCC" credit ratings. Constrained access to capital is usually an early sign that defaults will soon rise.
- BofA Research noted in July that a CCC-rated refinancing hadn't cleared the market since February. And overall high-yield issuance has slowed to a near-standstill, according to Leveraged Commentary & Data (LCD).
Threat level: In past recessions, default rates have spiked above 10%.
Yes, but: There’s reason to think they won’t climb nearly so high in the upcoming default cycle. That's because, for one, we just went through a default cycle two years ago that cleared weaker companies out of the bond market.
- For another, the exceedingly loose credit conditions of 2021 allowed companies to virtually eliminate near-term maturities. Goldman Sachs estimates there's just $125 billion of high-yield bonds maturing in 2023 and 2024 combined (that jumps to around $200 billion per year starting in 2025).
- Last year's loose conditions also mean companies can better afford their debt — 36% of U.S. high-yield bond issuers have a coupon of less than 5%, a claim that only 16% of issuers could make in December 2019, as Oaktree Capital Management wrote in a recent market commentary.
- Finally, credit quality in the high-yield market has also improved over the last decade. Bonds with a credit rating of BB (the highest high-yield rating) now constitute 53% of the U.S. high-yield bond market, up from 43% in 2012, Oaktree notes.
The bottom line: Those conditions may take the edge off the pain of the next default cycle. But they won't prevent it altogether.