With a recession looking less likely, the outlook for U.S. corporate defaults has improved but the default rate is still expected to rise, says S&P Global Ratings Credit Research & Insights.
The rating agency expects corporate defaults to rise to 4.75% this year amid weak cash flows and higher interest expenses. The default rate started 2024 at 4.5%.
“Given positive momentum with GDP, inflation, and interest rates in 2024, we expect defaults to decline in the fourth quarter but finish the year higher than 2023,” S&P said in a report.
In a gloomier scenario, the default rate could hit 6.75%: “In this scenario, economic growth would slow to a crawl, or possibly enter recession. While we anticipate core inflation to fall this year, stickier or higher levels would be a considerable obstacle for borrowers if the Fed keeps rates elevated, providing a double challenge to firms’ ability to service debt,” the rating agency said.
However, at this point, “a recession is looking less likely in 2024.”
In S&P’s more optimistic scenario, economic growth would continue to surprise to the upside, while both inflation and interest rates would fall.
“If consumers remain resilient, this would result in a ‘soft landing’ for the economy and financial markets,” it said. In this scenario, the default rate could fall to 3.25% by the end of the year.
S&P’s forecast of 4.75% represents a slight improvement from its previous projection of a 5% year-end default rate.
“We expect defaults in 2024 to largely come from consumer-facing sectors, such as consumer products and media and entertainment, as well as the still highly leveraged health care sector,” it said.
“As rates stay higher for longer, we expect weakening consumer balance sheets to squeeze consumer spending on discretionary items (like streaming services) in 2024. Further, persistently high interest rates put refinancing pressure on lower-rated companies with near-term maturities, as many are unable to survive with higher interest burdens,” S&P said.
While interest rates are expected to ease in the year ahead, S&P said it does not anticipate rate cuts before mid-year, “keeping interest burdens high through most of 2024.”
Additionally, S&P said market sentiment has improved over the past few months, with spreads falling and bond issuance resuming as companies refinance existing debt.
“This has helped reduce the amount of speculative-grade debt coming due in the next year or two,” it said. “But while issuers have been able to find funding for existing debt, the cost to maintain it has risen since 2022.”
These higher costs will pose an ongoing challenge for issuers, S&P noted.
“Despite the boost in market sentiment, credit fundamentals remain strained,” it said.