What does Your Default Model Forecast?

1) Moody’s expects the global speculative-grade nonfinancial corporate default rate to reach 4.9% by April 1, 2024. Subsequently, Moody’s credit model calls for a decrease to 4.1% on Q2/2024, before stabilizing between 3.7% to 4.0% in 2H of ‘24. Elevated SOFR base borrowing rates will keep default rates elevated from historical averages, negatively impacting many highly levered companies. In Europe, the EU growth rate has been anemic, while the U.S. GDP growth has been surprisingly resilient despite a big gap between IG credit and B- rated companies (most B- are burning cash to service debt). Industry sectors led by durable consumer goods, business services, healthcare, and high-tech industries to be most challenged with many restructurings likely to unfold. Moody’s projects the US speculative-grade default rate to peak at 5.8% in the first quarter 2024 and remain elevated through 2024. Loan defaults are likely to exceed bond defaults, given elevated SOFR rates and greater leverage ratios.

2) Morningstar’s LSTA US Leveraged Loan Index shows a 2.05% issuer count and 1.53% amount payment default rate, with a 3.84% dual-track default rate by issuer count. This 25-year data for the US leveraged loans began in October 1998 averaging 2.67% (amount) and 2.47% (count). The current 3.84% dual-track rate is nearing the pandemic peak compared to the traditional payment default rate.

3) Bank of America Securities recently concluded its study that I found quite interesting. While the Moody’s analysis centers on rated HY bonds/BSL, BofA’s report evaluated direct lending associated with Middle Market Lending, an asset class that has grown to $1.6 trillion outstanding par amount. BofA’s Corporate Credit report states US Private Credit implied leverage is ~ 6x with Direct lending (DL) recently becoming vulnerable to potential restructurings as well given leverage ratios and higher financing costs (+200bp higher for DL issuers vs. BSL market). While Direct Lending generates higher yields vs. its liquid counterpart (BSL), the rate burden for an obligor has resulted in a “meaningfully higher trailing 12-month private default rate that rose to 7.7% vs 2.5% for the overall HY market,†BofA said, noting the risk premium on Direct Lending provides “a good margin of safety for new money entering the asset classâ€

Projected default rates certainly vary across sources – KBRA reported Direct Lending defaults of 2.1% in 2023 and to increase to 2.75% in 2024, with BSL at 5.8%.

Global Credit managers will have a busy 2024 if Moody’s, LSTA data, BofA and KBRA are directionally correct. While many aggressive legacy lenders must now contend with problem loans in their portfolio, there will be a big need for creative capital that offers flexible solutions. Private Credit fund managers like Marathon Asset Management is laser focused on this opportunity as we selectively provide Capital Solutions to quality companies in need of funding.