Less than a month ago, Moody’s warned that “the prolonged environment of low growth and low interest rates has been a catalyst for striking changes in nonfinancial corporate credit quality,” and adds that “the record number of highly leveraged companies has set the stage for a particularly large wave of defaults when the next period of broad economic stress eventually arrives.”
This was followed by an ominous warning from Bill Derrough, the former head of restructuring at Jefferies and the current co-head of recap and restructuring at Moelis:
“I do think we’re all feeling like where we were back in 2007,” he told Business Insider: “There was sort of a smell in the air; there were some crazy deals getting done. You just knew it was a matter of time.”
Which makes sense when one notes that since 2009, the level of global nonfinancial junk-rated companies has soared by 58% representing $3.7 trillion in outstanding debt, the highest ever, with 40%, or $2 trillion, rated B1 or lower. Putting this in contest, since 2009, US corporate debt has increased by 49%, hitting a record total of $8.8 trillion, much of that debt used to fund stock repurchases.
Meanwhile, as a percentage of GDP, corporate debt is at a level which on ever prior occasion, a financial crisis has followed.
And while all this chaotic risk is building, risk appetite is flashing red signals for the analysts at CreditSights. As Bloomberg reports, students of history will find two parallels to today’s credit market – and neither will provide much comfort. According to a key valuation metric, investors are headed for the kind of bullishness on high-yield bonds that’s been seen just twice before: during the halcyon days of 1997’s tech bubble before the Asia crash, and on the eve of the global financial crisis a decade later.
The ratio between U.S. junk-bond yields and their high-grade counterparts has reached levels that “hearken back to the high risk appetite days of October 1997 and June 2007,” CreditSights Inc. strategists Glenn Reynolds and Kevin Chun wrote in a note this week.
That’s “not a great set of dates along the credit market timeline of overconfidence,” they noted.
“The fear is that the market is underestimating the threat of trade wars and European political instability and what turns they could take,” Reynolds and Chun wrote.
And as that risk appetite surges, so LeveragedLoan.com reports that US High Yield Bond issuance tumbled in May…
In what is typically an active period for the U.S. high-yield market, just $15.3 billion of deals were issued in May, making it the lightest volume for that month since the paltry $9.5 billion in recession-era May 2010, according to LCD
And finally, adding one more straw to the irrepressible credit bid camel’s back is news that Bloomberg reports Deutsche Bank is seeking to sell its portfolio of non-investment grade energy loans, worth about $3 billion, according to people with knowledge of the matter.
The potential firesale comes as Deutsche’s short-dated CDS (counterparty risk) is soaring..
And comes as European HY Energy debt is weakening notably and US HY Energy is as good as it gets…
Bloomberg reports that Deutsche is planning to sell the loan book as a whole and has marketed it to North American and European peers, said one of the people. The portfolio is expected to sell for par value, said the people, who asked not to be identified because they weren’t authorized to speak publicly; good luck with that!
The bank’s energy business is expected to wrap up on June 30, one of the people said. The bank has been an active lender in the energy space in the past year, participating in the financing of companies including Peabody Energy Corp. and Coronado Australian Holdings Pty., according to data compiled by Bloomberg.
So to summarize: Moody’s is warning that when the economy weakens we will see an avalanche of defaults like we haven’t seen before; Corporate debt-to-GDP and investor risk appetite is reminding a lot of veterans of previous credit peaks; and now the most desperate bank in the world is offering its whole junk energy debt book in a firesale… just as high yield issuance starts to slump.
All of which raises more than a single hair on the back of our previous lives in credit necks… and reminds us of this…
Thank you all for coming in a little early this morning. I know yesterday was pretty bad and I wish I could say that today is gonna be less so, but that isn’t gonna be the case. Now I’m supposed to read this statement to you all here, but why don’t you just read it on your own time and I’ll just tell you what the fuck is going on here. I’ve been here all night… meeting with the Executive Committee. And the decision has been made to unwind a considerable position of the firm’s holdings in several key asset classes. The crux of it is… in the firms thinking, the party’s over as of this morning.
“For those of you who’ve never been through this before, this is what the beginning of a fire sale looks like.” – Sam Rogers, Margin Call
There’s gonna be considerable turmoil in the Markets for the foreseeable future. And *they* believe it is better that this turmoil begin with us.
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