European, US leveraged default rates expected to rise further in 2024

January 09, 2024 (MLN): Leveraged finance default rates increased in 2023 in Europe and the US and will continue to rise in 2024 due to high-interest cost burdens and macroeconomic pressures, Fitch Ratings says.

Both the European and US leveraged finance sector outlooks remain deteriorating.

High-interest expenses will weigh on highly leveraged companies that in many cases are already operationally challenged, generating low or negative free cash flow, or cannot organically grow EBITDA to offset increased interest rates.

Source: Fitch Ratings

Furthermore, we expect the rise in defaults to be driven by sector-specific issues in the healthcare and pharmaceutical, telecom, and technology sectors.

Fitch forecasts default rates for European high-yield bonds and leveraged loans to rise to 4% in 2024 and 2025 from 2.5% and 3% respectively in 2023.

Highly leveraged credits in interest-rate-sensitive and cyclical sectors remain vulnerable to approaching maturities.

A quarter of European high-yield bonds will mature in 2025, of which 32% are rated in the ‘B’ category or below.

In contrast, only 11% of European leveraged loans will mature in 2025, although 97% are rated in the ‘B’ category or below.

Fitch forecasts 2024 default rates of 3.5%–4% for US leveraged loans, and 5%–5.5% for US high-yield bonds.

This is above our 2023 estimations of 3%–3.5% for loans and bonds and reflects the negative implications of a sharp slowdown in US economic growth in 2024, sustained contraction of capital market funding and the pressure that higher-for-longer interest rates will exert on speculative-grade issuers.

European developed market issuers defaulted on €10.5 billion of high-yield bonds in TTM to November 2023, representing a 2.3% default rate, up from EUR6.2bn and 1.3%, respectively, at the end of 2022.

The default rate was slightly higher at 2.8% in the leveraged loan market, representing €11.1bn of default volumes in the 12 months to November 2023.

The return of Adler Group and Adler Real Estate to Fitch’s Market Concern list following their default in early 2023 highlights the propensity for repeat defaults if incumbent creditors do not write down sufficient debt during initial restructurings.

US high-yield bond default volumes totaled $44.5 billion, from 47 unique issuers, in 2023 (a 3.1% default rate), up from $25.7 billion in 2022.

Of those 47, five issuers defaulted more than once, including Mallinckrodt, which missed an interest payment in July and then went on to file for Chapter 11 in August, and WeWork, which completed a distressed debt exchange (DDE) in May, and then missed an interest payment in October and ultimately filed for Chapter 11 in November.

US leveraged loan default volumes totaled $50.5bn (a 3% default rate) from 67 unique issuers in 2023, four of which defaulted more than once.

Repeated default issuers include West Marine, which completed loan DDEs in February and September, QualTek USA LLC, which completed a restructuring in March only to file for Chapter 11 in May, multiple missed payments by Anchor Glass Container Corp., and Strategic Materials Inc., which filed for Chapter 11 on 5 December after missing multiple interest payments in August.

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