Rising corporate bankruptcies and debt defaults are another headwind for the economy, experts warn

• A wave of corporate bankruptcies and debt defaults could rock the economy, experts say.
• Charles Schwab expects bankruptcies and defaults to peak at some point over the next two quarters.

There's a wave of corporate defaults and bankruptcies that could be coming as high interest rates batter US companies.

Experts warn it could raise the odds of a recession as high interest rates take their toll on businesses and consumers alike. 516 companies have filed for bankruptcy as of the end of September, according to S&P Global. That number already surpasses the total number of bankruptcy filings recorded in 2021 and 2022.

US corporate debt defaults have also been on the rise. This year has seen 127 corporate defaults as of the end of October, according to a separate S&P Global report, 13% more compared to the five-year average.

Charles Schwab director and fixed income strategist Collin Martin estimates that borrowing costs for some firms doubled or nearly tripled in 2023 compared to previous years, taking a heavy toll on corporate balance sheets.

Illustrating the rising costs for companies, effective yields for below-investment grade corporate debt soared past 9% in October, and traded around 8.5% last week, according to the ICE BofA US High Yield Index.

And though bond yields have eased slightly, the yield on the 10-year US Treasury touched a 16-year-high in September, which influenced borrowing costs across the economy. The 10-year yield traded around 4.42% on Monday.

"When corporations are managing their balance sheets and looking to issue or refinance debt, they have to issue debt with significantly higher yields than what they've seen over the past number of years, and that's just a big hit to their earnings. It's more interest they have to pay, which can affect their corporate profits in an environment where revenues are already slower," Martin said.

He says that's especially tough for so-called zombie firms, which are companies that don't have the cash on hand to service their debt. Many zombie companies managed to survive in an ultra-low interest rate environment, when the cost of borrowing was close to zero and firms could keep rolling over and refinancing debt with relative ease.

But that's changed in a higher interest rate regime, and it appears to be contributing at least in small part to the wave of distress building in the corporate sector.

Defaults of high-yield bonds are expected to notch 4.5%-5% by the end of this year, according to Fitch Ratings, more than six times the 0.7% default rate recorded among all high-yield bond issuers in 2021.

Recession fears

Total US bankruptcies and debt defaults are likely to surge into 2024, Martin said. The US could see defaults and bankruptcies peak sometime by the end of the first quarter of 2024, Charles Schwab estimates.

And that rise of corporate defaults and bankruptcies between now and then adds to the list of headwinds that could knock the US economy into a recession. Firms struggling through bankruptcy or with heavy debt burdens could slash their workforces as they try to get back to financial health. It's also a negative for asset prices, specifically, for high yield bonds and bank loans, which could bleed over into pain for stock prices as well.

"If companies are struggling, that should be a negative for stock prices. And if you're an investor and your assets are going down, the declining wealth effect might impact our spending habits. Add these dual forces of losses and lower spending … it can be something that makes the economy slow," Martin added.

Other signs the economy may soon slow are also beginning to sprout up. Consumers are running out of excess savings piled up during the pandemic, the restart of student loan payments is set to pressure spending, and soaring bond yields are set to ratchet up borrowing costs all throughout the economy.

Meanwhile, the yield curve — the bond market's notorious recession gauge — has started to de-invert, something market experts say has historically signaled a recession could be coming in the near term.