The concerns of escalating corporate debt defaults and their impact on the global economy, which were previously overlooked due to robust credit markets, are now becoming a reality.

Increasing numbers of companies are experiencing downgrades to a junk credit rating, leading to elevated borrowing expenses. Retailer Casino, burdened with a net debt of 6.4 billion euros ($7.19 billion), is engaged in discussions with creditors under court supervision.

Similarly, Britain's Thames Water, carrying a debt of 14 billion pounds ($18.32 billion), has garnered attention in the media.
Despite being at the center of a property crash that poses a threat to Sweden's economy, Swedish landlord SBB, which was downgraded to junk status in May, investors appear unconcerned about the increasing risks of defaults.

Last week, the cost of insuring against exposure to a collection of European junk-rated companies briefly reached its lowest level in over a year. This suggests a prevailing sense of complacency in the market, even though data indicates that global defaults in the first five months of 2023 have already matched the total number seen in the entire year of 2022, as highlighted by Markus Allenspach, the head of fixed income research at Julius Baer.

Despite the aforementioned complacency, there are still capital inflows into high-yield bonds, according to Markus Allenspach.

However, S&P Global anticipates an increase in default rates for sub-investment grade companies in the United States and Europe. By March 2024, S&P Global projects the default rate for U.S. companies to reach 4.25%, up from 2.5% in March of the same year.

Similarly, the default rate for European companies is expected to rise to 3.6% from 2.8% during the same period.

Optimism regarding the global economy's ability to evade a severe downturn, coupled with expectations of an imminent halt to aggressive interest rate hikes, helps elucidate the positive sentiment prevailing in the market.

However, analysts caution that the full consequences of interest rate increases have not yet been fully realized.

Consequently, some analysts argue that corporate bond yields should demand a higher premium. Currently, the spread on the ICE BofA global high yield bond index stands at 435 basis points (bps), which is a decline from 622 bps recorded a year ago.

While some companies took advantage of the low interest rate environment to extend the duration of their debt, providing them with additional time, refinancing will pose a significant cost burden for those facing impending debt maturities. Guy Miller points out that although the overall situation may not appear dire, the concern lies with the marginal players who now face significantly higher borrowing costs.

ABN AMRO highlights that the average maturity of European high yield corporate bonds hit a record low of nearly four years in May. In comparison, during the period of 2005-2007, when the European Central Bank also raised rates, the average maturity stood at just over six years. This shortened maturity period implies that companies now have less time to refinance their debt, thereby accelerating the impact of higher interest rates.

Companies facing challenges in meeting higher interest expenses and refinancing maturing debt are at risk of corporate defaults.

To avoid insolvency, these companies are initiating discussions with creditors to restructure their debt and revive their business operations. One such example is Casino, which is seeking at least 900 million euros in fresh capital to sustain its operations while reducing its debt burden. The legal systems for debt restructuring have evolved since the financial crisis, allowing for more orderly business resolutions.

In Spain, a new restructuring law is being tested through the evaluation of a plan for industrial group Celsa. The alignment of legal frameworks across European countries has improved the predictability of outcomes in restructuring processes.

However, not all companies may withstand the challenges posed by extensive debt, higher interest and business costs, and declining profits.

Experts suggest that the full impact of these factors, particularly in Europe, may take another year to materialize, with the recovery process expected to be slower in the region.