Default rate will rise this year, Moody’s says

Diving brief:

  • JThe default rate for speculative-grade corporate debt will gradually increase to 2.4% by the end of 2022, from 1.7% at the end of last year, remaining well below average at long-term growth of 4.1% as companies navigate tighter monetary policy in many countries, according to Moody’s Investors Service.
  • “The default outlook for 2022 will continue to depend on the pace of economic growth, inflation levels and central bank monetary policy in response, pandemic management and vaccine distribution,” said Moody’s. “Monetary policy will be key in determining whether capital markets will remain open to high-yielding companies seeking refinancing.”
  • In a pessimistic scenario, the default rate could jump to 9.1% at the end of 2022 if a new disruptive variant of the coronavirus emerges, if trade or geopolitical tensions worsen, if inflation leads to a withdrawal of stimulus measures and a declining liquidity, or if China’s “regulatory reset” triggers a sharp decline in credit growth and availability, Moody’s said.

Overview of the dive:

CFOs assessing the extent of their borrowing this year face an unusual range of risks, including the highest inflation in four decades, the prospect of another COVID-19 outbreak and investors’ expectations. which the Federal Reserve, the Bank of England and the European Central Bank will raise their benchmark interest rates.

“Inflation concerns have prompted many central banks to signal their intention to end quantitative easing and raise interest rates,” Moody’s said. In the United States, “monetary policy will likely continue to support economic growth, even if it will be less accommodative than it was at the start of the pandemic”.

Fed policymakers began cutting record stimulus late last year. In mid-December, central bank officials scheduled three quarter-point increases in the federal funds rate for 2022, the first at their next meeting on March 15-16.

Private sector forecasters expect the Fed to tighten more than three times this year. Such expectations and a surge in prices pushed the yield on the benchmark 10-year Treasury to 2% from less than 1.2% in August.

The Fed’s efforts to rein in inflation by raising the main interest rate could push up the default rate “but won’t necessarily lead to a default rate cycle,” Moody’s said.

“Inflation is not a leading indicator of the default rate,” Moody’s said. “In fact, during the economic downturns that followed the dotcom bubble, the global financial crisis, and the onset of the COVID-19 pandemic, inflation fell while the default rate reached cyclical highs.”

A slow tightening of monetary policy is unlikely to shake credit markets, according to Moody’s. “Gradually rising rates will increase corporate borrowing costs but will not necessarily hamper credit fundamentals significantly without economic shocks.”

Still, Moody’s did not rule out the possibility of a liquidity crunch.

“Macro trends and market conditions could turn adverse if infection rates increase significantly and impede the recovery of economic activity,” Moody’s said. “Aggressive monetary policy tightening could pose a threat to the global economic recovery, which could slow or prevent companies from restoring earnings and cash flow to healthy levels.”

Businesses focused on accommodation, gambling and leisure face the prospect of a default rate of 3.6% in 2022, the highest of any industry. “The sector has recovered from the 2020 shutdowns, but its longer-term recovery remains vulnerable to further virus outbreaks.”

The corporate default rate is expected to fall to 1.5% in the second quarter before ending the year at 2.4%, according to Moody’s.

“We believe these forecasts are consistent with the overall strong fundamentals of rated issuers,” Moody’s said. “These fundamentals include good earnings, healthy balance sheets and strong liquidity.”

The default rate during the pandemic period peaked at 6.9% in December 2020, well below the 13.4% in September 2009 during the global financial crisis, Moody’s said.

Building and construction companies defaulted last year at a faster rate than any other sector, Moody’s said. Eight of the nine companies unable to repay their debt were in China, where regulators moved to reduce leverage in the property market.

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