Outlook 2023: Higher defaults in store across markets; distressed debt exchange leading cause

By Cristal Cody

Tupelo, Miss., Dec. 30 – Defaults are on the agenda for 2023 with widely expected rising forecasts in the debt and leveraged loan markets as investors brace for a recession.

S&P Global Ratings said it expects the U.S. trailing 12-month speculative-grade corporate default rate to hit 3¾% by September 2023, up from 1.6% in September 2022, since it now forecasts a recession in 2023 as inflation remains high, consumer sentiment is falling and floating-rate debt costs continue to rise.

If a deeper or longer recession takes hold, a 6% default rate is not out of the question, S&P said.

The global corporate default tally totaled 77 as of Nov. 30, beating the year-to-date 2021 total by five defaults, S&P said.

Fitch Ratings said it expects the par-weighted default rate to end 2022 at 1½% to 1¾%.

2023 default rates are anticipated at 2½% to 3½% for high-yield bonds and 2% to 3% for leveraged loans, reflecting the likelihood the U.S. economy will fall into a mild recession, Fitch said.

Market participants widely are taking a dim view of the credit landscape in the year ahead.

BofA Securities analysts estimate a default peak of 5% in 2023, but a more likely rate in the 4% to 5% range.

Bond traders also are eyeing higher defaults in 2023.

“I do expect the default rate to rise a bit,” a trader said. “Nothing crazy, more like the 3% to 4% area.”

Emerging markets defaults

Defaults are expected in other markets as well.

“One big, and more concerning trend we anticipate for 2023 is a return of defaults,” BofA’s Barnaby Martin, head of EMEA credit strategy, said in a note. “For the last decade, defaults have been the one absent feature of the European HY market. The distressed ratio across the European HY market has fluctuated between 15-20% lately. It has been the best predictor of future defaults in Europe. Thus, we anticipate a default rate of around 4% in European HY in 2023.”

Defaults also are expected to stay high in China’s high-yield property sector with an estimated forecast rate of 40.9%, according to the report.

By late 2022, 43 Chinese developers had defaulted on $62.6 billion, pushing the default rate to 73.2% by amount as of Nov. 17 from 40.7% at the end of 2021, Martin said.

Distressed debt exchanges

Distressed exchanges were the leading reason for defaults by late 2022, contributing to 42% of defaults globally, S&P said.

Distressed debt exchanges accounted for 41% of U.S. default volume in 2022, well above the 13% historic total, according to Fitch.

The debt exchanges conducted in 2022 came from issuers that included Diamond Sports Group LLC in March, Wolverine Escrow LLC in April, Envision Healthcare Corp. in May, Bausch Health Cos. Inc. in September, Rite Aid Corp. in July and again in December, along with Diebold Nixdorf Inc. and Bed Bath & Beyond Inc. in December, according to market sources.

Bed Bath & Beyond extended offers to exchange its senior notes from Dec. 5 to Dec. 19 and then again to Jan. 4.

Distressed debt exchanges also accounted for 10 out of 18, or 56%, of defaulted credits in the emerging markets space over the past 12 months, Fitch said.

In 2023, the rate of distressed debt exchanges is expected to remain high, given limited refinancing alternatives and growing maturities coming due through 2025, Fitch said.

“Default rates are rising across U.S. and European high-yield and institutional leveraged loan markets in 2023 and 2024, primarily due to weaker macroeconomic growth and rising interest rates,” Fitch said. “Higher interest rates and weaker capital access will keep distressed debt exchanges above historical averages next year, particularly in the LL market that has become more receptive to DDEs.”

Names on block

Consumer-driven sectors led defaults in November, accounting for four defaults out of eight for the month, S&P said.

The year saw Chapter 11 bankruptcy filings from issuers including Talen Energy Supply LLC in May, TPC Group Inc. in June, Revlon Consumer Products Corp. in June and Endo International plc in August.

By the third quarter, cumulative liabilities of all large bankruptcies above $100 million from January through September had surpassed the cumulative default amount for the same time period in 2021, according to a KBRA report.

“Further, the 2022 total bankruptcy level looks likely to surpass that of 2018 if the accelerated pace of bankruptcies continues,” the agency said.

Just in the period from Dec. 8 through Dec. 14, Prospect News reported six new defaults that included Chapter 11 filings from American International Group, Inc. subsidiary AIG Financial Products Corp. and Sears Hometown Stores, Inc.

By early December, Prospect News had reported 157 defaults over the year, including 79 Chapter 11 filings, 33 missed interest payments, 13 missed principal and interest payments, 10 Chapter 15 filings, eight missed principal payments, two each of bankruptcies, schemes of arrangements and liquidations, and one each of Chapter 7 filings, judicial managements, recapitalizations, reorganizations, missed interest payments paid within a grace period, administrations, restructurings and missed payments.

Several larger high-yield defaults likely will be concentrated in the retail, telecommunications and broadcast media spaces in 2023, sources report.

Diamond Sports and Exela Technologies, Inc. could undertake distressed debt exchanges again in 2023, while Party City Holdings Inc. also could arrange an exchange in the new year for its 2025 and 2026 notes, Fitch said.

“We think there’s going to be a couple of large names that are being restructured, and some of them already are in the process,” Oleg Melentyev, BofA’s head of U.S. high-yield credit, said in December.

“Situations like DSports, Bausch and Ligado, these are not new stories,” he said. “People are saying defaults are going higher, but I know who they are and I’m pricing them accordingly. We think a lot of this is already in the pricing.”

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