In recent weeks, corporate bankruptcies (companies with more than $50 million in liabilities) have been spiking as reported by Apollo research, a trend that coincides with bond yields hitting the 4% mark. This level was previously associated with significant financial crises such as the Silicon Valley Bank collapse and the UK pension fund crisis.
Despite the escalating financial stress, the Federal Reserve maintains a ‘higher for longer’ stance in an attempt to curb inflation. This is happening amidst a U.S core CPI inflation rate persistently above 5% and the Fed funds rate.
Market Professionals Anticipate Stress
A recent survey conducted by Deutsche Bank indicates that over half of market professionals anticipate market stress due to higher rates. While 20% foresee minimal impact, approximately 17% warn of potential severe financial stress.
Stricter Credit Standards Impacting Businesses
Businesses are finding it increasingly challenging to secure loans due to stricter credit standards, a consequence of higher rates. Historically, tighter lending standards precede recessions, as evidenced in 1989, 1999, and 2007. In each case, the Federal Reserve was in a tightening cycle.
The stricter credit standards align with the rise in bankruptcy filings, as per Apollo research. It’s important to note that the bankruptcy filings are from companies with liabilities exceeding $50 million, a specific sample. A broader view of total U.S. bankruptcy court filings from a different dataset presents a different narrative. Bankruptcy filings remain low on a relative basis, but have been trending higher.
The Beginning of a Default Rate Surge
The current default rate is merely the beginning. As the Fed sustains high rates, bankruptcy figures are set to worsen. While 2023 sees limited debt maturing, refinancing concerns escalate from 2024 onwards.
In 2023, approximately $700 billion of debt matures, sparing businesses that refinanced at low rates in 2020/21 from higher rate environments. However, 2024 sees debt maturity surge to $1 trillion, with 30% being speculative grade. By 2025, this figure rises to $1.2 trillion, with speculative grade debt constituting 40%.
The Market’s Current Lack of Concern
The market’s current lack of concern stems from the economy’s delayed response to interest rate hikes since 2022, which also explains the persistently low credit spreads. Credit spreads, indicative of credit risk pricing in financial markets, typically rise ahead of recessions, as seen in 2001, 2008, and 2020.
Despite recent bankruptcies, credit spreads remain stable due to two factors: most companies have yet to refinance their debt, and the economy has not yet entered a recession.
The Market’s Likely Response to Restrictive Rates
As the Fed persists with restrictive rates, the market is likely to price in more risk as bankruptcies increase. This could lead to wider credit spreads and lower stock prices, with the peak panic occurring during the recession.
In summary, while credit markets remain calm for now, the rising tide of corporate bankruptcies amidst high interest rates points to growing financial stress. As more speculative-grade debt comes up for refinancing over the next few years, defaults may surge, potentially catalyzing the next recession. Investors should keep a close eye on credit spreads for signs of when the markets will start pricing in this growing risk. Click here to get free trial for 7 days! Subscribe to our YouTube channel and Follow us on Twitter for more updates!
Read more: The Tech Sector: A Comparative Analysis of Valuations from the Dot Com Era to Today
