Expected Wave of Corporate Failures Stays at Bay

As the coronavirus crisis continues to affect U.S. companies and trigger defaults and bankruptcy filings, a recent article in The Wall Street Journal reports that, for the most part, “the companies that have succumbed were already heavily indebted and in industries that were declining before the pandemic.”

The hit to the top line due to the shutdown, the article says, “tipped them over the edge.”

The outlook for healthier companies, however, has “brightened considerably over the past couple of months,” the article reports, due in large part to the Fed’s unprecedented purchase of corporate bonds, which allowed companies (including Boeing, General Motors and Royal Caribbean) to raise capital and avoid defaults.

At the same time, the article notes an uptick in sentiment regarding the economic recovery spurred by stronger-than-expected employment, retail, and new-home sales data in May. “While those gains have been tempered by recent surges of coronavirus cases in some states, there is a widespread view that state and local governments lack the political will to reimpose the kinds of broad shutdowns that  brought economic activity to a virtual standstill in March and April.”

Some companies have reported a return of demand that exceeded expectations, the article reports, adding that while the default rate among U.S. speculative-grade borrowers has risen compared to a year ago (from 2.3% to 4.7%), it is “still a far cry from the November 2009 postcrisis peak of 12.1%.”

But the article notes that although the feared wave of corporate failures hasn’t materialized, there’s no guarantee it won’t: “The new debt companies are taking on  could come back to bite them if their businesses don’t recover quickly enough or fail to regain prepandemic levels.”

According to S&P, default rates for speculative-grade U.S. companies are expected to reach 12.5% for the twelve-month period ended March 2021. That said, the rating agency “acknowledges the potential for a range of outcomes due to the unprecedented and unpredictable nature of the crisis,” the article notes, adding, “In the most optimistic  scenarios, the default rate would reach only 6% by next March, while S&P’s downside case is for a 15.5% rate.”

But the article lists the following reasons to doubt the downside scenario:

  1. Restructuring advisers say that most struggling companies have already received default waivers for the second and third quarters. The article adds, “Private-equity firms also have a boatload of unspent cash that they could use to keep portfolio companies afloat.”
  2. Many private-equity-backed deals were financed with “covenant-lite” loans intended to afford borrowers more leeway.