A surge of debt maturities in the coming years poses a growing threat to the solvency of companies in the US high-yield market.

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The prospect of higher-for-longer interest rates ratchets up the risk that a sharp spike in debt maturities in 2024 and 2025 will have to be refinanced at much higher costs, raising the potential for defaults.

Some $106.7 billion of speculative-grade nonfinancial debt matures in 2023, according to S&P Global Ratings. That more than doubles to $247.7 billion in 2024 and rises further to $389.3 billion in 2025, a volume comparable with the investment-grade universe, where the refinancing costs are lower and the pool of investors far greater.

"Defaults will certainly increase over the next two years due to a combination of tighter financial conditions from elevated debt costs, decelerating economy and the refinancing requirements from upcoming maturities," said Steven Oh, global head of credit and fixed income, co-head of leveraged finance at PineBridge Investments.

Risk of defaults rises

Sticky inflation increases the prospect that the default rate will become and stay elevated as the US Federal Reserve keeps interest rates high. When the record levels of bond issuance during the worst of the COVID-19 pandemic begin to mature, they will have to be refinanced at a significantly higher cost. Companies not only snagged cheaper rates, but also pushed out maturity profiles when they refinanced in 2020 and 2021.

While investment-grade companies are expected to pull back from debt-fueled mergers and acquisitions and research and development to improve their balance sheets and creditworthiness, weaker companies will find it harder to deleverage.

"They don't have the levers to pay down their debt with free operating cash flow, their costs are going up even higher and they didn't have a ton of free operating cash flow to begin with," said Gregg Lemos-Stein, head of analytics and research at S&P Global Ratings.

S&P Global Ratings expects the US trailing-12-month speculative-grade corporate default rate to reach 4.25% by March 2024, up from the historically low 2.5% in March 2023. If there is a deeper and longer recession and a higher rate of inflation, Ratings forecasts the default rate to rise to 6.25%, a total of 115 defaults.

Defaults to rise, but no outsized spike expected

About 14.9% of speculative-grade US-rated companies are considered "weakest links" by Ratings, meaning they are rated B- or lower with negative outlooks or on CreditWatch negative with companies such as Brand Industrial Services Inc., PHMC II Inc. and H-Food Holdings LLC. The most common reason for these outlook revisions was high leverage.

Declines in creditworthiness can lead to substantially higher costs of borrowing.

"There's a cost of every notch along the credit spectrum, but the big juncture is investment grade to speculative because it's a different market. A good portion of investors don't invest in spec," Lemos-Stein of Ratings said.

Yet, despite the refinancing pressures, the default rate is not expected to reach the double-digit heights seen in recessions in the 1990s, the dot-com bubble or Great Recession.

"We do not expect the default rate to spike significantly," said Timothy Crawmer, director and head of global credit at asset manager Payden & Rygel. "The vast majority of high-yield companies have been prudent over the last few years by using free cash flow to lower leverage and taking advantage of periods of market strength to extend maturities when possible."

PineBridge's Oh agreed, assuming any approaching recession ends up being mild.

"Default rates will simply increase from recent period of ultra-low levels back upwards toward long-term historical averages," Crawmer added.