Powell’s wake-up call means more corporate failures: Credit Weekly

(Bloomberg) – America's most indebted companies faced a painful reality check this week as Federal Reserve Chair Jerome Powell warned that a rate cut is still a couple of years away.

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Businesses must accept higher borrowing costs longer while finding a way to manage their debt. Rising funding costs increase the risk of defaults and distressed exchanges as companies struggle to adjust to a shrinking money supply.

According to data compiled by Morgan Stanley, by January companies will have about $260 billion in debt due over the course of a year, about double current levels. From there, the debt wall continues to grow as cheap loans taken out during the pandemic have to be refinanced.

“If these monetary conditions last as long as the Fed says, we will see high mortality in the corporate sector and that process is just beginning,” said Juan Carlos Ureta, chairman of Renta 4 Banco in Madrid.

It's a major blow to CFOs who had hoped the Fed would ease up and reverse rate hikes amid the uncertain economic outlook. At least some junk-rated companies held back from issuing new debt this year and last, hoping yields would fall.

As fewer companies refinanced their debt, the average maturity of junk bonds in the index fell to just over five years, the lowest on record, according to data from Bloomberg.

More debt to refinance increases default risk, which analysts at Deutsche Bank AG are likely to peak at 9% for US high yield and 11% for leveraged loans in the fourth quarter of next year.

“‘Higher for longer' puts more pressure on lower-quality borrowers,” strategists at MS, including Srikanth Sankaran, wrote in a note this week. “For smaller, lower-quality companies, the adjustment could well be disruptive as maturity lines loom until 2025.”

Some companies resort to distressed exchanges, which may include debt-to-stock swaps and debt buybacks at a discount, to avoid bankruptcies. Sometimes, however, the measures only serve to delay the pain.

For example, according to Moody's, 16 companies defaulted on payments last month. Six of them had done so before, four of which ran distressed exchanges.

Companies that opted for these transactions have had mixed fortunes this year: WeWork Cos recorded an 86% participation rate in its debt swap, while Carvana Co. called off a painstaking swap earlier in the month because bondholders didn't get enough participation.

“Those deals have to be much larger and much cheaper for borrowers,” said Sonal Desai, chief investment officer of Franklin Templeton Fixed Income.

For now, the higher lending rates continue to impact the bottom line. According to a survey by data provider Calcbench Inc., interest costs for US companies rose 22% year over year in the first quarter.

Longer-term higher interest rates could fail companies with troubled business models, said Jeremy Burton, portfolio manager at PineBridge Investments.

“It won't necessarily be the ultimate cause of the default, but the proximate cause of the default,” he said. “Companies that are struggling with earnings declines or pressures in the short or long term have less time to sort things out.”

Weekly review

  • Bed Bath & Beyond Inc. has selected Overstock.com Inc. as the lead bidder in an upcoming bankruptcy auction for the right to own the major retail store's brand.

  • Private lender Blue Owl Capital Inc. is considering a move into European direct lending, which could involve building a team or buying an existing fund manager.

  • A group of investors including Anchorage Capital Partners and BlackRock Inc., which hold more than 1 billion euros ($1.09 billion) worth of SBB bonds, have hired PJT Partners to counter efforts by competing creditors who are claiming , the company is threatened with failure.

  • Banks are discussing swapping bonds for hybrid bonds, an unusual solution to the dilemma facing Europe's $220 billion market.

  • Mallinckrodt Plc has reached an agreement to defer a $200 million opioid settlement originally due June 16 as the company continues to evaluate options to restructure its balance sheet.

  • China's dollar junk bond market has started to reverse its four-month decline as authorities mull a sweeping package of stimulus measures to boost the economy. The country's central bank cut short-term interest rates last week.

Traveling

  • According to an internal memo seen by Bloomberg, Nick Darrant, co-head of Citigroup Inc.'s debt capital market syndicate, is retiring from the industry and Tim Michael becoming sole head. Darrant said his next destination will be Rwanda.

  • The Bank of America Corp. appointed Chris Dodman as co-head of global debt advisory and Jon Mullen and Wajeeh Faheem as co-heads of North American capital markets for syndicated loans.

  • BNP Paribas SA is hiring a number of new hires as the company continues to grow its credit business, including Greg Ford, who is moving from Stifel Nicolaus & Co. as Managing Director to lead Distressed Credit in the Americas. Mike Romanowski also joins as managing director of distressed sales, having worked at Credit Suisse Group AG, as well as Chris Hynes and Hal Steiner, also from Credit Suisse. Hynes and Steiner will take on the roles of directors, focusing on high yield trading and high yield research, respectively. Dennis Lu will serve as Director of High Grade Trading.

  • The Bank of America Corp. adds two BNP Paribas SA senior executives to its team trading credit default swaps, namely Matt Mandell, former head of US single CDS trading at BNP, and Eric Deutsch, who also focused on single CDS trading . Name CDS.

  • According to a bank spokesman, Mitsubishi UFJ Financial Group has hired Keith Zusi as a trader for its loan sales team within its capital markets group.

– With support from Charles Penty and Dayana Mustak.

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