Pockets of corporate credit look particularly vulnerable after ballooning during the years of rock-bottom interest rates, when even faltering companies could easily borrow to delay the reckoning. — Bloomberg
NEW YORK: Richard Cooper’s phone is something of an early alarm bell for the global economy. Lately, it’s been ringing a lot.
A partner at Cleary Gottlieb, a top law firm for corporate bankruptcies, he’s advised businesses worldwide for decades on what to do when they’re drowning in debt.
He did it through the global financial crisis, the oil bust in 2016 and Covid-19. And he’s doing it again now, in a year when big corporate bankruptcies are piling up at the second-fastest pace since 2008, eclipsed only by the early days of the pandemic.
“It feels different than prior cycles,” Cooper said. “You’re going to see a lot of defaults.”
His perch has given him a preview of the more than US$500bil (RM2.3 trillion) storm of corporate debt distress that’s already starting to make landfall across the globe, according to data compiled by Bloomberg.
The tally is all but certain to grow. And that’s deepening worries on Wall Street by threatening to slow economic growth and strain credit markets just emerging from the deepest losses in decades.
On the surface, much of it looks like the usual churn of capitalism, of companies undermined by forces like technological change or the rise of remote work that has emptied office buildings in Hong Kong, London and San Francisco.
Yet underneath there’s often a deeper, and more troubling, through-line: Debt loads that swelled during an era of unusually cheap money.
Now, that’s becoming a heavier burden as central banks ratchet up interest rates and appear set to hold them there for longer than nearly everyone on Wall Street expected.
The rising tide of distress is, of course, to a certain degree by design. Caught by surprise as inflation surged, monetary policymakers have been aggressively draining cash from the world’s financial system, intentionally seeking to slow their economies by stanching the flow of credit to businesses. Inevitably, that means some will fail.
But pockets of corporate credit look particularly vulnerable after ballooning during the years of rock-bottom interest rates, when even faltering companies could easily borrow to delay the reckoning.
In the United States, the amount of high-yield bonds and leveraged loans, which are owned by riskier, less creditworthy businesses, more than doubled from 2008 to US$3 trillion (RM13.63 trillion) in 2021, before the Federal Reserve (Fed) started its steepest rate hikes in a generation, according to S&P Global data.
Over the same period, the debts of non-financial Chinese companies surged relative to the size of that nation’s economy. And in Europe, junk-bond sales jumped over 40% in 2021 alone.
A lot of those securities will need to be repaid in the next few years, contributing to a US$785bil (RM3.6 trillion) wall of debt that’s coming due.
With growth cooling in China and Europe, and the Fed expected to continue raising rates, those repayments may be too much for some businesses to bear.
In the Americas alone, the pile of troubled bonds and loans has already surged over 360% since 2021, the data show.
If it continues to spread, that could lead to the first broad-based cycle of defaults since the Great Financial Crisis.
“It’s like an elastic band,” said Carla Matthews, who heads contentious insolvency and asset recovery at consulting firm PwC in the United Kingdom.
“You can get away with a certain amount of tension. But there will be a point where it snaps.”
That’s starting to happen already, with more than 120 big bankruptcies in the United States alone already this year.
Even so, less than 15% of the nearly US$600bil (RM2.7 trillion) of debt trading at distressed levels globally have actually defaulted, the data show.
That means companies that owe more than half a trillion dollars may be unable to repay it, or at least struggle to do so.
This week, Moody’s Investors Service said the default rate for speculative-grade companies worldwide is expected to hit 5.1% next year, up from 3.8% in the 12 months that ended in June.
Under the most pessimistic scenario, it could jump as high as 13.7%, exceeding the level reached during the 2008 and 2009 credit crash.
Of course, much remains uncertain. The US economy, for one, has remained surprisingly resilient in the face of higher borrowing costs, and the steady slowdown in inflation is raising speculation the Fed may be steering the economy to a soft landing.
Yield spreads in the US junk-bond market, a key measure of the perceived risk, have also narrowed since March when the collapse of Silicon Valley Bank briefly sowed fears of a credit crisis that never materialised.
Yet even a relatively modest uptick in defaults would add another challenge to the economy.
The more defaults rise, the more investors and banks may pull back on lending, in turn pushing more companies into distress as financing options disappear.
The resulting bankruptcies would also pressure the labour market as employees are let go, with a corresponding drag on consumer spending.
“You’re going to see situations, for example, in the retail sector, where the business just doesn’t make sense and no amount of balance sheet fixing will cure the ills of a particular debtor,” Cooper said.
In London’s Canary Wharf, HSBC’s name is emblazoned on the top of the 45-story office tower that’s been its headquarters for two decades.
It’s one in a constellation of big banks that turned the once-derelict riverside in east London into a world financial centre.
Even before the pandemic, banks were quietly scaling back on office space in London, reflecting both cost cuts and the United Kingdom’s exit from the European Union. Remote work has accelerated it.
That’s fallen particularly hard on Canary Wharf. Two buildings owned by Chinese property developer Cheung Kei Group were taken over by receivers after loan payments weren’t made.
In June came more bad news: HSBC said it’s planning to leave by late 2026. That’s another blow for Canary Wharf Group, the developer whose credit rating has already been cut deep into junk as vacancy rates rise and retailers there struggle.
It has more than £1.4bil (US$1.8bil or RM8.18bil) of debt coming due in 2024 and 2025.
No other industry is facing pressure as acute as commercial real estate due to the slow return to offices that’s emptied buildings and thinned out downtowns.
More than a quarter of the distressed debt worldwide, or about US$168bil (RM763.14bil), is tied to the real estate sector, more than any other single group, the data show.
There seems to be little relief on the horizon. A survey by property broker Knight Frank found that half of the international firms it surveyed are planning to cut down on office space.
Coaxing tenants back can be expensive, particularly as businesses look for more environmentally friendly workspaces.
“Tenants have bargaining power now,” said Euan Gatfield, a managing director at Fitch Ratings.
Most of the distressed debt linked to the property sector is a result of the real estate bust in China.
As China Evergrande Group restructures its debt, major companies like Dalian Wanda Group Co and Country Garden Holdings Co have seen the prices of their debt tumble.
In the United States, co-working giant WeWork Inc, whose losses have piled up since its 2020 initial public offering, has bonds due 2025 that currently yield around 70%. — Bloomberg
