S&P Global Ratings expects the U.S. trailing-12-month speculative-grade corporate default rate to fall to 3.5% by December 2025, from 5.1% in December 2024.  The default rate had been falling through third-quarter 2024 but rose by year-end, almost entirely because of increased distressed exchanges, which reached roughly 65% of all defaults in the fourth quarter. Macrofinancial factors like stubbornly high interest rates have been a source of moderate stress for the weakest-rated borrowers--not enough to induce bankruptcy, but enough to force many to seek reprieve from borrowing costs.

Nonetheless, tight spreads, lower benchmark borrowing costs for loan issuers, and more manageable near-term debt are helping many issuers to better service their debt. And for now, we expect economic growth to slow but continue in 2025, while earnings have remained strong. However, downside risks are growing.

Chart 1

In our optimistic scenario, we forecast the default rate could fall to 2.25%.  In this scenario, interest rates would fall faster than anticipated if inflation declines, but such a decline has proved elusive thus far amid a growing likelihood of increased tariffs and extended tax cuts in the face of rising government debt. More likely, rates could be cut out of necessity to offset the slowing growth widely expected in the coming quarters.

In our pessimistic scenario, we forecast the default rate could rise to 6%.  The threat of rising U.S. tariffs, including 10% tariffs on Chinese imports and 25% tariffs on Canadian and Mexican imports, is becoming more real. But tariffs' impact on future defaults could be somewhat limited over the next 12 months, considering their ultimate timing and the relatively small number of weaker-rated issuers from subsectors most reliant on these imports.

Less clear is the potential impact on defaults in service sectors from changes in immigration policies, which could affect labor markets and economic growth. Such uncertainties may not automatically result in increased defaults, but vulnerability is higher given the weak ratings distribution since 2020 (see chart 2).

Chart 2

The Age Of Distressed Exchanges

We expect the U.S. speculative-grade corporate default rate to decline in the near term, but more slowly than its recent ascent. The 5.1% default rate as of December reflects macroeconomic fundamentals as well as situational debt restructurings and distressed exchanges initiated to avoid more traditional default events (involving otherwise lower recovery levels). Through the end of 2024, the distressed exchange default rate was 3.2%, compared with a default rate of 2% for all other types of default (see chart 3).

The distressed exchange default rate has never before surpassed the default rate for more traditional defaults except in 2021, when defaults were declining after the pandemic-induced recession. But now, distressed exchanges have led the default rate upward, in the absence of a recession. This dynamic likely results from prolonged higher interest rates, which have stressed weaker-rated issuers, but not enough to force more traditional defaults, given resilient economic growth and market expectations for rates to decline.

Chart 3

Supportive Markets Portend Fewer Defaults

Bond spreads fell through most of 2024, with some short-lived widening in early August before hitting an all-time low in early December of 214 basis points (bps). Markets remain hungry for yield even though Treasury yields have flirted with 5% recently.

The U.S. speculative-grade corporate spread indicates future defaults based on a roughly one-year lead time (see chart 4). At 227 bps in December, the average speculative-grade bond spread implies a much lower default rate by December 2025. Even loan spreads--which ended December at 424 bps--remain relatively favorable, given the large percentage of leveraged loans in the U.S. rated 'B' or 'B-'.

Chart 4

That said, the corporate distress ratio (defined as the proportion of speculative-grade bonds trading with option-adjusted spreads of 1,000 bps or more over Treasuries) is a more targeted indicator of future defaults across credit and economic cycles, especially during periods of less stress. The distress ratio indicates future defaults with a roughly nine-month lead. The 4.3% distress ratio in December would approximately correspond to a 2.4% default rate for September 2025 (see chart 5).

Chart 5

Using the CBOE Volatility Index, the ISM Purchasing Managers' Index, and components of the money supply, we estimate that in December, the average speculative-grade bond spread in the U.S. was about 220 bps below the implied level (see chart 6).

Chart 6

Tightening spreads often signal opportune times for companies to come to the market, and spreads over the last 12 months have certainly reflected that. A total $900 billion in speculative-grade bonds and leveraged loans was issued in 2024--second only to the record-setting $1.2 trillion in 2021 (see chart 7). Nonetheless, roughly three-quarters of the total went toward refinancing existing debt--a historically high percentage.

Chart 7

This large amount of issuance helped reduce the near-term refinancing obligations for speculative-grade issuers (see chart 8). Maturing debt due 2025-2027 totals roughly $803 billion, compared with $882 billion due 2024-2026. However, even if near-term maturities have shrunk, the 2028 total of $746 billion remains sizable.

Chart 8

Credit Indicators Continue Moderate Improvement

Market signals have been bullish, but many other credit and economic indicators remain more challenging (see table). Bank lending conditions continue to tighten, the yield curve remains inverted after nearly two years, and the number of weakest links (issuers rated 'B-' or lower by S&P Global Ratings with negative rating outlooks or ratings on CreditWatch with negative implications) remains elevated. Credit conditions appear to be stabilizing, but defaults remain slightly above the long-term average.

Upgrades Keep Momentum

Upgrades have outnumbered downgrades over the last 12 months, and net bias (the share of issuers with ratings that have positive outlooks or CreditWatch implications minus the share of ratings with negative outlooks or CreditWatch implications) has become less negative in recent quarters, suggesting a modest pace of net downgrades in the future (see chart 9). A major spike in defaults therefore appears unlikely in the near term.

Chart 9

In the fourth quarter, just two of the 13 sectors we track had positive net bias, one reached zero, and the remaining 10 had negative net bias (see chart 10).

Chart 10

Downgrades of speculative-grade issuers have increased since the start of the COVID-19 pandemic, and the share of issuers rated 'CCC' to 'C' has grown (see chart 11). However, following the increase in defaults in 2023, the proportion of these issuers has started to decline in the past 12 months. These lowest-rated issuers have historically had much higher default rates, and we expect them to remain stressed over the next few quarters.

Consumer

Consumer-reliant sectors accounted for 43% of U.S. defaults in 2024, down from 51% the year prior, though consumer conditions largely deteriorated. The consumer products sector had the highest number of defaults, at 18. The consumer products sector also had the highest number of weakest links at the end of December, with 29, though this tally was down from the beginning of the year.

High interest rates and the cumulative effects of inflation have depleted consumer savings and discretionary income, particularly for lower-income borrowers. Larger price gaps and increased availability of products have allowed private label products to gain market share relative to branded peers as supply chains have normalized.

Health care

The health care sector had the second-highest tallies of defaults and weakest links in December, with 16 and 23, respectively. This sector is more vulnerable to cash flow disruptions amid high interest rates and inflation, given its larger share of issuers rated 'B-' or below that have floating-rate debt. These highly leveraged companies continue to struggle with inflationary and labor pressures.

Health care spending is on the rise due to increased utilization, keeping labor costs elevated. Meanwhile, inflation is also contributing to the rise in spending and may lead to tougher pricing negotiations and increased claim denials, which would pressure margins and cash flow.

Media and entertainment

The media and entertainment sector had the third-highest number of defaults last year, with 15, after leading all sectors in 2023. It also tied with health care for the second-highest number of weakest links in December, with 23.

Several legacy media companies have finally attained profitability in streaming, which could support higher cash flow in 2025. Moreover, both industry companies and investors are optimistic about potentially more supportive conditions for mergers and acquisitions, though sizable deals aren't likely in the near term. But sticky inflation and higher interest rates will likely continue to weaken consumers' discretionary spending, especially for media.

While issuers in this sector refinanced large amounts of debt through the fourth quarter, helping to curb near-term risk, companies rated in the 'B' category or lower with high leverage and weak competitive positioning continue to confront challenges in refinancing upcoming maturities.

Chart 11

How We Determine Our U.S. Default Rate Forecast

Our U.S. default rate forecast is based on current observations and on expectations of the likely path of the U.S. economy and financial markets.  In addition to our baseline projection, we forecast the default rate in optimistic and pessimistic scenarios. We expect the default rate to finish at 2.25% in December 2025 (37 defaults in the trailing 12 months) in our optimistic scenario and 6% (98 defaults in the trailing 12 months) in our pessimistic scenario.

We determine our forecast based on a variety of factors, including our proprietary analytical tool for U.S. speculative-grade issuer defaults.  The main components of the analytical tool are economic variables (the unemployment rate, for example), financial variables (such as corporate profits), the Federal Reserve's senior loan officer opinion survey on bank lending practices, the interest burden, the slope of the yield curve, and credit-related variables (such as negative bias).

In addition to our quantitative frameworks, we consider current market conditions and expectations.  Factors we focus on can include equity and bond pricing trends and expectations, overall financing conditions, the current ratings mix, refunding needs, and negative and positive developments within industrial sectors. We update our outlook for the U.S. speculative-grade corporate default rate each quarter after analyzing the latest economic data and expectations.

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