Looming liquidity crunch to drive defaults: Moody’s

With a sharp decline in debt issuance this year, corporate liquidity will come under pressure, leading to a surge in defaults, says Moody’s Investors Service in a new report.

As new issuance drops, default risks are rising, the rating agency said.

So far this year, “global leveraged finance issuance has plunged to around US$315 billion from a record US$1.6 trillion in 2021,” it said.

To date, default activity this year has been concentrated in the Asia-Pacific region, driven by the turmoil in China’s property sector, Moody’s reported,

But as global financial conditions deteriorate, higher defaults are expected in North America and Europe.

Currently, the rating agency’s liquidity stress indicators for the U.S. and Europe are “relatively healthy,” it said. “An influx of liquidity support from central banks during the pandemic has provided a cash cushion, along with last year’s record refinancing activity and strong earnings performance.”

But the risks are rising, as refinancing and new issue activity has dropped.

“This, along with rising interest rates and economic stresses, points to a darkening outlook for 2023,” the report said.

Lower-rated companies are most vulnerable, Moody’s noted.

“Economic pressures will take a toll on top-line growth and profit margins, with rising debt costs hitting [B2 rated] and lower companies hardest,” it said, adding that these weak companies make up more than 60% of the speculative-grade issuers in the U.S. and almost 70% in Europe.

“Most carry high financial leverage, large exposures to floating rate [covenant-lite] debt and are owned by private equity, increasing the likelihood of defaults,” it said. “Moreover, simple top heavy debt structures will lead to worse recoveries on defaulted debt.”

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.