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Uncertainty over the pace and timing of major central banks' interest rate cuts, the global economic outlook, and intensifying geopolitical tensions are putting particular pressure on corporate issuers rated 'CCC+' and below—and contributing to a continual increasing number and frequency of defaults.

What We're Watching

The trifecta of higher-for-longer interest rates, economic uncertainty, and intensifying geopolitical risks is compounding pressure as 2024 takes shape. Challenging conditions promise to persist, especially for the riskiest credits—which S&P Global Ratings defines as corporate issuers rated 'CCC+' and below, the level at which most defaults generally occur.

Last year's bond issuance in the 'CCC' rating category fell to just $2.96 billion, the lowest since 2008 and down 79% from the previous year. Meanwhile, by year-end 2023, the share of corporate borrowers rated 'CCC+' and below grew to 12.6% of speculative-grade issuers in North America (its highest since March 2021), normalized to 9% in Europe (around the five-year average), and stayed at about 11% in emerging markets (providing a slight silver lining).

The situation for these credits remains precarious. The market's lowest-rated issuers generally continue to struggle with weak business risk profiles, highly leveraged capital structures, and looming debt maturities.

Current trends are not particularly positive: The 'CCC+' and below rating categories continue to account for a large percentage of total downgrades, with nearly a quarter of all downgrades in February. Amid the high number of rating transitions for these vulnerable credits, S&P Global Ratings' Credit Research & Insights expects defaults to remain elevated (with the speculative-grade corporate default rate for issuers rated 'BB+' or below likely to reach 4.75% in the U.S. and stabilize at 3.5% in Europe by December). This trend is evidenced by this year's global corporate default tally rising to 29 as of last month—marking its highest year-to-date count since 2009, and representing a trend unlikely to end soon after borrowers rated 'CCC+' or below accounted for 89% of defaults in 2023 and 97% of defaults so far in 2024.

What We Think And Why

The steady (and, in the case of the U.S., growing) share of corporate borrowers rated 'CCC+' and below is particularly noteworthy because these credits are naturally much more likely to default than other speculative-grade borrowers. In fact, borrowers we identify as weakest links (those rated 'B-' and below) are eight times more likely to default than the rest of speculative-grade borrowers—with issuers rated 'CCC+' or below accounting for the majority of weakest links' defaults.

Media and entertainment and health care companies face the biggest risks, considering that February's defaults were mainly concentrated in these two sectors (with three defaults in each spread across the U.S. and Europe). Adding further pressure, both sectors will see substantial amounts of speculative-grade debt maturing in the next 36 months. The 2024-2025 peak in maturities for issuers rated 'CCC+' and below will prompt the most pronounced challenges, particularly while 'CCC' yields remain prohibitive.

On the brighter side, global corporate earnings are showing signs of stabilizing. Based on about half of companies reporting fourth-quarter results, revenues at an annual rate are roughly flat (down just 0.6%) and EBITDA has slipped 3.9%, the same decline as in the third quarter. Revenues in the latest reporting period decreased only 0.2% versus the same quarter a year ago, while EBITDA is off 1.2%. In short, the recent earnings recession has been modest by historical standards.

What Could Change

Major central banks' rate cuts, the global economy's steadying outlook, and any potential easing of geopolitical tensions could all contribute to improving financing conditions for the riskiest credits. On the other hand, sustained elevated borrowing costs, a pullback in consumer and/or business spending that results in slowing GDP growth, or the escalation of the Middle East and Russia-Ukraine military conflicts could continue to act as a drag for these borrowers.

Currently, 70% of 'CCC+' and below issuers have either a negative outlook or are on CreditWatch negative, meaning they are at risk for a further downgrade or default. This compares to only 20% of speculative-grade issuers—leaving little wiggle room for a downside scenario.

On the horizon, S&P Global Ratings sees a rosier economic picture in the U.S. and the likelihood of a soft landing in the eurozone (albeit one that results in economic expansion far behind that of the world's most powerful economy).

Better-than-anticipated growth in the fourth quarter of 2023 and a sturdy jobs market led us to revise our projection, and we now forecast U.S. real GDP growth of 2.4% this year—up from our November forecast of 1.5%, and only slightly below the estimated 2.5% expansion last year.

To be sure, the downside of this growth for borrowers is that the Federal Reserve is unlikely to rush its lowering of interest rates, even with inflation moving closer to the central bank's target. We believe the Fed won't lower its policy rate probably until June, by 25 basis points (bps), with cuts totaling just 75 bps this year.

For Europe, a soft landing remains the most likely near-term scenario—although the eurozone economy looks set to expand just 0.8% this year. And many factors could derail this projection, not the least of which are the tenuous resilience of labor markets; inflation expectations, which haven't receded at the same pace as consumer prices; and still-elevated all-in borrowing costs.

Writers: Molly Mintz and Joe Maguire