- The default rate among non-financial U.S. companies will likely triple to 4.8% by September 2023, with tighter credit especially straining companies in the durable goods, telecommunications and automotive sectors, Moody’s Investors Service said in a report.
- “A perfect storm of rising interest rates, bleaker economic outlook, weakening credit quality are setting the stage for speculative-grade downgrades and defaults in the year ahead,” Moody’s said.
- Loan-only debt issuers backed by private equity firms made up most defaults during the third quarter and the trend will likely persist in coming months, according to Moody’s. “Given the PE [private equity] prevalence within the B3 and below space, we expect an increase in defaulting LBOs [leveraged buyouts] as credit conditions continue to deteriorate.”
CFOs sizing up the credit market face conflicting forecasts for U.S. economic growth and signals by Federal Reserve officials of their intent to increase borrowing costs in coming months.
Fitch Ratings predicts that a mild recession will begin during the second quarter of 2023, while Moody’s Analytics says that the economy will probably avoid a downturn and slow to 1% growth next year before strengthening to a 2.3% gain in 2024.
The economy shrank during the first two quarters this year — meeting the common definition of a recession — but grew at an annual rate of 2.6% during last quarter. A rebound in U.S. exports helped revive growth, with shipments of oil and natural gas rising in response to trade disruptions from Russia’s invasion of Ukraine.
“Our baseline forecast is still for the Fed to engineer a soft landing and the economy to skirt a recession with inflation returning over time to the central bank’s target” of 2%, Moody’s Analytics said in a separate report. “The economy is very vulnerable and may need some luck to avoid a recession.”
The central bank — combatting the worst price pressures in nearly four decades — has raised the federal funds rate since March to 3.25% from 0.25%.
Several policymakers have indicated the likelihood of a 0.75 percentage point increase in the main interest rate on Nov. 2. It would be the fourth consecutive Fed tightening of that magnitude.
Fueled in part by higher borrowing costs, the 12-month trailing default rate for non-financial companies will likely triple to 4.8% next September from 1.5% at the end of September 2022, Moody’s said.
“Our moderate to severe pessimistic forecasts anticipate 9% and 14.4% respectively, depending on how severe risks get from rising interest rates, the Russia-Ukraine military conflict, pandemic concerns or the slowdown in China,” Moody’s said, referring to the next 12 months.
Beyond next September, the default rate will probably remain above the 4.7% long-term average, according to Julia Chursin, a senior analyst with the Corporate Finance Group at Moody’s.
“A growing share of negative industry sector outlooks for the next 18 months, rating distributions, unabated inflation and rising interest rates coupled with an even bleaker macroeconomic outlook” will likely keep the default rate comparatively high, Chursin said in an email response to questions. Moody’s does not publish default forecasts beyond 12 months, she added.
Default rates among companies involved in consumer durable goods, telecommunications and the automotive sectors will likely rise by next September to 7.6%, 7% and 6.7%, respectively, Moody’s said.