Vulnerable emerging-market companies are facing increasing challenges as global borrowing rates reach their highest levels since the financial crisis, hindering their ability to refinance around $400 billion worth of debt maturing in the coming year.
The surge in US Treasury yields to 15-year highs and rising borrowing costs have made it difficult for companies in developing nations to roll over their debt, with only a fraction of the required amount successfully refinanced. Moreover, the refinancing situation is likely to worsen when an additional $300 billion worth of corporate bonds come due in 2025.
Money managers and credit-rating agencies believe that the longer interest rates remain elevated, the more complex the situation will become. High-quality companies may face increased interest rates, while lower-rated ones could experience failed refinancing deals, potentially leading to defaults or even bankruptcies.
According to Sergey Dergachev, a portfolio manager and emerging-market corporate debt expert at Union Investment Privatfonds GmbH, some companies in countries such as China, Argentina, Brazil, and Ukraine are particularly vulnerable to refinancing challenges.
This situation is already unfolding in various locations, from Colombia to Dubai, where companies have had no choice but to refinance their upcoming maturities at significantly higher interest rates. For instance, Colombia's Ecopetrol SA had to pay 8.625% and 9% to borrow $1.5 billion in June, representing a substantial 4-percentage-point increase in its borrowing costs over two years. Dubai-based Shelf Drilling Holdings Ltd. recently sold $1.1 billion of bonds at a 10.125% yield, the highest coupon rate it has ever offered.
In 2023, emerging-market corporates have already defaulted on $26 billion of debt, bringing the total missed repayments during the Federal Reserve's current tightening cycle to $80 billion. This is a substantial increase compared to just $9.3 billion in 2021 and $9.5 billion in 2020.
The concern primarily lies in the high-yield segment, where weaker credit quality companies are expected to underperform and face funding constraints as interest rates rise. As a result, allocations to single B/CCC and frontier markets should be reduced, according to Warren Hyland, a money manager at Muzinich & Co.
Even though opportunities are typically found in distressed markets, traders who anticipated relief in emerging-market debt distress this year, leading to bond price gains, have been disappointed. The Bloomberg EM USD Aggregate Corporate Index has resulted in a total loss of 0.6% for money managers this year, in contrast to the 4.3% gain from a similar gauge of US high-yield corporate debt. Consequently, investors are becoming more cautious in the primary market for hard-currency borrowing.
While the majority of corporate debt maturing in emerging markets is investment grade, a significant portion faces junk-rated issuers over the next two years. This is where most money managers anticipate the most refinancing challenges and deal failures.
High-yield companies have struggled to refinance bonds this year, with only one in four successful deals coming from junk-rated companies. These lower-rated companies have collectively raised just $11 billion in refinancing, significantly less than the $75 billion in 2021. As their investment appeal erodes due to refinancing pressures, higher-rated firms benefit.
Access to dollar and euro funding sources has become scarcer, but lower-rated companies that can explore alternative options like local-currency bonds or bank loans may navigate the refinancing bottleneck more effectively. The competition among issuers for liquidity is expected to intensify over the next two years, especially for lower-rated ones, as S&P Global analysts have noted. The window for debt sales for riskier companies may start to close as the year-end holidays approach and tensions in the Middle East escalate.
In this challenging environment, some borrowers are closely monitoring market conditions to find a favorable issuance window, but the timing for risky names may become more opportunistic from November. External debt cash flows from emerging markets will be significant in the next few years, and some borrowers may struggle to refinance at sustainable rates in international bond markets in the context of a "higher for longer" US Treasury yield environment.
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