A Mountain of Junk Debt Is Coming Due: Should We Be Concerned?

In a recent Financial Times article, it was mentioned that,

"Almost $2tn worth of speculative-grade debt and loans reach maturity in the next five years, according to Moody’s Ratings, of which $438bn is due by the end of 2028. That might seem like a long way away, but finance departments like to get this sort of thing sorted in plenty of time: by the middle of next year, even a late-2028 maturity will feel uncomfortably close."

And to give you perspective, the FT provided this graph:

As I have mentioned in other posts, the era of easy credit has fueled the large increase in junk debt, almost doubling over the last decade. The FT highlights the concern that much of this debt will likely need to be refinanced at higher interest rates, putting pressure on corporate profitability.

It is difficult to say how this increase in financing costs will affect the viability of individual firms, but certainly I expect some of the companies that make up this population will find themselves in economic difficulties and possibly default. Examining the delinquency rate on business loans in the graph below, which I view as an early warning indicator of corporate defaults, we can see that it remains relatively low compared with most of the past 30 years. While this metric does not capture all the speculative-grade debt referenced in the FT article, it is nevertheless a good holistic measure of default risk.  

Having said that, historical data shows that those rates can change rather quickly and suddenly.

Conclusion

While delinquency rates remain subdued, history suggests that can change rather quickly. The fact that a large amount of junk debt must be refinanced over the coming years should concern us because of the fragility it could create within the economy. If borrowing costs remain elevated, some issuers of junk debt may struggle to meet their obligations when refinancing becomes necessary. It starts with one company, then another, and then another. Before long, a broader credit event can emerge, with the potential to spill over into the wider economy. Before that happens, however, I would expect delinquency rates to begin trending upward. We are not there yet. But "yet" is the operative word.