High U.S. Interest Rates Drive Corporate Defaults

The current environment of elevated interest rates in the United States is having a profound impact on corporate America, potentially pushing many companies into default. For over twenty years, U.S. businesses have enjoyed favorable interest rates, fueling significant borrowing through loans and bond issuances. However, with the Federal Reserve implementing eleven rate hikes in less than two years, borrowing costs have surged, placing immense pressure on companies across various sectors.

Even large multinational corporations are feeling the pinch, finding it increasingly expensive to borrow internationally due to high interest rates in regions like the United Kingdom and the European Union. The repercussions of these high interest rates are becoming apparent, as troubled loans and bonds are on the rise, alongside a notable increase in corporate default rates. This trend is raising concerns among banks, which have substantial exposure to these leveraged companies through various channels, including direct lending, investments in bonds and stocks, and financial derivatives transactions.

The impact of rising corporate defaults extends beyond banks, affecting asset managers, insurance companies, pension funds, and university endowments, all of which have invested heavily in leveraged companies in search of higher yields during the low interest rate era. Fitch Ratings’ Top Market Concern Bonds report, as of January 24, 2024, has reached a total of $65.5 billion, marking a significant 42% increase from the previous month. Furthermore, the default rate for leveraged loans has risen to 3.4% as of mid-January 2024, the second highest level since 2007.

Travelport, LLC, a travel and entertainment company, stands out as one of the largest leveraged loan defaults in recent months, with outstanding loans totaling $4.3 billion. Looking ahead, S&P Global is forecasting default rates for below investment grade bonds to reach 4.75% by the end of 2024, highlighting the ongoing challenges faced by highly leveraged companies.

In addition to the broader corporate landscape, the healthcare sector is under particular strain due to high interest rates and labor shortages. BankruptcyData.com reports that more than 80 healthcare companies filed for bankruptcy in 2023, the highest level in five years. In January 2024 alone, healthcare companies accounted for 35% of the outstanding $76.5 billion in Fitch Ratings’ data for the top leveraged loans and high yield bonds of concern. Bausch Health Companies Inc. is among those with significant exposure, holding over $15 million in loans and bonds of concern.

To navigate these challenging conditions, financial institutions should consider increasing their capital and liquidity, especially if they have exposure to vulnerable sectors such as commercial real estate, healthcare, and telecommunications. Banks can also bolster their reserves to mitigate the impact of rising nonperforming loans. Regulators play a crucial role in ensuring that financial institutions review and enhance their hedging strategies with creditworthy counterparties. With the specter of increasing corporate defaults looming large, both financial institutions and regulators must act swiftly and decisively to protect the financial system from potential shocks.