Overstated

At the end of April, the 12-month-trailing speculative-grade default rate in the U.S. reached 4.9%. The last time it rose to this level was in the first half of 2020 during the height of the pandemic. However, in the current environment, the old adage "this time is different" could apply, to some extent. Credit stress is indeed increasing in response to rising interest rates. However, several factors are also at play that may make systemic credit stress lower than a higher-than-average default rate may imply.

Distressed Exchanges Lead Defaults

This period of defaults is unique in that now a majority of the defaults included in the calculation are a result of distressed exchanges (see chart 1). Distressed exchanges first became a sustained majority from May 2021 through March 2022, during the downswing in the default rate peak from December 2020. This time --and a historical first--they are leading among defaults while the default rate has been increasing with a distressed exchange default rate of 2.7% in April, compared with a default rate of 2.2% for all other default types (combining for a 4.9% overall headline default rate).

Chart 1

As we've observed in our annual recovery studies, distressed exchanges bring much higher recovery rates than other types of defaults, close to 20% higher across all bonds and notes. This is particularly true for more junior tranches of debt (see chart 2).

So although defaults are rising again, this also marks the first time they have been dominated by distressed exchanges. This is pushing the overall 2023 recovery rate to 66% for all speculative-grade bond debt, from 70% in 2022, despite the default rate more than doubling between 2022 and 2023.

Chart 2

Falling Issuer Count Contributes To Default Rate

Also contributing to this round's default rate acceleration is a historically rare trend of the number of rated issuers falling at a time when the default rate is low and the economy is growing (see chart 3). Since September 2021, the U.S. speculative-grade population has declined by 304 issuers, pushing the total down to where it was in roughly September 2013.

Typically, our rated population of issuers will decline during recessionary periods with a rising default rate, like the global financial crisis in 2009, or the COVID-19 pandemic in 2020. But the population of speculative-grade issuers in the U.S. has been falling since September 2021, while the default rate was both low and falling, amid resilient economic growth.

Chart 3.

However, this decline has roughly coincided with the interest rate hikes by the Federal Reserve and could be attributed to more issuers seeking alternative funding apart from public bond or loan markets, though this is difficult to prove.

If we were to assume the speculative-grade population held steady at the 1965 issuers last seen on Sept. 30, 2021, this would have reduced the 4.9% default rate through April 2024 to 4.3%. This assumption may not be out of line as only three issuers that defaulted during 2023 through April 2024 were those whose ratings were removed since mid-2021.

As part of our research surveillance, we include in our default statistics issuers that were previously rated but defaulted after having their rating withdrawn (assuming sufficient information is readily available outside of our rating processes). However, these are typically limited to bankruptcy and selective defaults (including distressed exchanges) that can also occur in private transactions.

Of the issuers whose ratings were withdrawn since September 2021, more than half were rated either 'B' or 'B-' just prior to withdrawal (see chart 4). This has left relatively more 'CCC'/'C' rated issuers behind, contributing to an arguably riskier rating distribution, which could have also contributed to an otherwise higher default rate.

Chart 4

Repeat Defaulters Increase

Another unique attribute of the current default environment is the relatively high contribution from frequent, or repeat, defaulters (see chart 5). Repeat defaulters will likely become an increasing proportion of all defaults over time as more issuers ultimately join the list of defaulters who re-emerge afterwards and receive a new active rating.

Also somewhat intuitively, repeat defaulters will also account for a larger proportion of the total in years with fewer defaults, as many in cases like these will be weaker even in a more supportive economy. This held true in 2014, 2019, and 2021, but also in 2023 when defaults reached a historically high number.

Chart 5

But this recent group of repeat defaulters may be weaker than the norm. As shown, the average time between repeat defaults has fallen to near an all-time low in 2024, of only 1.4 years. Repeat defaulters in 2023 had an average time between defaults of about 2.79 years, which would mean that many of them may have also defaulted in 2020.

All this implies that the recent rise in defaults is receiving a large contribution from a set of specific issuers on more weaker footing than their peers. But this also reflects the high usage of distressed exchanges, which can often result in subsequent defaults, as we've previously shown (see "Credit FAQ: The Rise Of Repeat Defaulters," April 11, 2024).

But Was Some Of This Overdue?

Although the current default rate is not particularly high, it has risen fairly quickly from lows at the end of 2022. Hindsight is always 20/20, but in the months following the start of the pandemic, we posited that the default rate may follow one of multiple possible-shaped paths in the years ahead (see chart 6). One of the paths suggested, which may be playing out now, was an "M"-shaped default rate, characterized by multiple historically lower "peak" rates in succession, rather than the typical double-digit recessionary level peak rates seen in the past.

Chart 6

The thinking behind this scenario was that the U.S. might avoid a double-digit peak default rate considering the extraordinary fiscal and monetary supports established to assist an economy dealing with lockdowns in 2020 and 2021. Additionally, positive market sentiment in response to these supports contributed greatly to market liquidity. Trillions were either spent or promised, and indeed, speculative-grade issuers saw a breakout year for bond and loan issuance in 2021, characterized by the lowest yields in history. Arguably this backdrop helped keep defaults scarce, for a time.

However, joint fiscal and monetary expansion may have come at the price of the highest inflation rates in more than 40 years, which forced a quick reversal in interest rate policy. As a result, defaults eventually picked up--and that continues today, producing the second half of the "M" envisioned earlier (the first half hitting a peak in December 2020, with a 6.7% default rate).

It is of course speculation, but had these supportive policies not been in place, many more issuers could have defaulted in 2020 or even 2021. When looking at recent defaults from 2023 and 2024, we identified 40 issuers that were rated in 2020 that did not default until at least 2023. All these were rated 'B' or lower, and the majority (22) were rated 'CCC+' or lower at the end of 2020 (see chart 7). These 40 are a sizable portion of the 108 issuers that have defaulted since 2023 (this total excludes repeat default events) and were arguably "long-lived" in historical terms for those with such low ratings.

If we were to assume they would have defaulted in 2020 had it not been for the extraordinary supports at the time, this would have brought the 2020 default rate up to 8.8%, much closer to typical recessionary period levels, and adding more than 2% to the year-end default rate of 6.6%.

Chart 7.

Related Research

• Resilient Growth, Resilient Yields, And Resilient Defaults To Bring The U.S. Speculative-Grade Corporate Default Rate To 4.5% By March 2025, May 16, 2024

• Public-To-Private Borrowing Is A Two-Way Street, May 7, 2024
• The Rise of Repeat Defaulters, April 11, 2024
• A Rise In Selective Defaults Presents A Slippery Slope, June 26, 2023
• U.S. Recovery Study: Loan Recoveries Persist Below Their Trend, Dec. 15, 2023
• The U.S. Speculative-Grade Corporate Default Rate Could Rise To 9% By September 2021, Nov. 23, 2020