Higher-for-longer rates and approaching maturity walls will lead to an up-tick in high-yield and leveraged-loan defaults, including distressed debt exchanges and corporate bankruptcies, supporting the need for liability management and restructuring services from advisory firms, Fitch Ratings says.
Restructuring and advisory activity have historically counterbalanced each other, with a rise in restructuring activity often partially offsetting lost M&A revenue during a down cycle. That relationship, however, has broken down several times since the global financial crisis. Bankruptcy levels during the pandemic were abnormally low, as businesses accessed financing and capital at low rates, often paired with government stimulus. Additionally, in 2022-2023 low M&A volume driven by rate hikes, economic uncertainty and wide bid-ask spreads was not accompanied by meaningfully increased default activity.
In response to slow volumes in both M&A and restructuring, advisory firms have sought to broaden product and service offerings to diversify revenues and enhance earnings stability through different market environments. These include expanded financial sponsor coverage, private capital markets and fundraising, shareholder strategic advisory and special purpose acquisition companies (SPACs). Some firms also have wealth management businesses, which provide more stable management fees independent from transaction volumes.
Still, restructuring activity is expected to grow as bankruptcy filings continue to rise toward pre-pandemic levels, as protracted higher-for-longer interest rates and refinance risk from approaching maturities add strain to distressed borrowers. Overall corporate bankruptcy filings surged by 40% to 18,926 in 2023, normalizing from 13,481 filings in 2022, but remain around 18% below the pre-pandemic average from 2016 to 2019.
The trailing twelve-month (TTM) high-yield default rate edged up to 3.8% in March from 3.7% in February, according to Fitch’s U.S. Distressed and Default Monitor: April 2024 as eight issuers defaulted on their LL or HY debt. Distressed debt exchanges (DDEs) affected more than $9 billion of loans and $7.9 billion of HY debt, or 82% and 90%, respectively, of total March default volume.
Fitch is estimating 2024 default rates of 3.5%-4.0% for leveraged loans (LL), and 5.0%-5.5% for high yield (HY), up from 2023 default rates of 3.3% for leveraged loans and 2.8% for HY.
The number of announced distressed debt and bankruptcy restructurings rose by 124% to 280 in 2023 from 125 in 2022, suggesting that bankruptcies will continue to rise into 2024. The restructuring value increased from $142 billion in 2022 to $205 billion in 2023. Completed restructurings rose 134% to 164 deals in 2023 from 70 in 2022, but total value fell by 21%.
Fitch’s sector outlook for independent advisory firms is neutral for 2024, as we expect M&A volume to gradually increase with advisory earnings currently at cyclical lows and cash flow leverage at elevated levels. Revenues should improve due to increased restructuring activity, even absent rate cuts, or with the expected resumption of M&A activity.
