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Submitted by Eric Peters via EricPetersAutos.com,

Termites start low and work their way up. By the time you notice them, it’s often already too late to save the place. All you can do is rebuild, start over.

This analogy may be useful in terms of understanding what’s going on in the car business… on the lower end of that business. And what that could portend for the rest of the business – ostensibly “doing gangbusters,” according to mainstream media accounts.

You know … like the housing market was “doing gangbusters” a few years back.

Until, of course, it wasn’t.

Well, check this:

The number of “subprime” car loans being sold is increasing – and so is the number of delinquencies on those loans. They are up to 5.16 percent, the highest level in 20 years.

Consider what this means.

First, a growing number of people cannot get traditional loans for new cars. They lack the verifiable income to qualify – or their credit scores suck. But financial flimflam outfits are loaning them money – often, at exorbitant interest – nonetheless.

Sound familiar?

It does to Comptroller of the Currency Thomas Curry, who recently said “… what’s happening in the auto loan market reminds me of what happened in mortgage-backed securities in the run-up to the (housing) crisis.”

Second – and not surprisingly – these loans are being defaulted on in growing numbers. Apparently, people who can’t swing a mainline loan at 3 or 4 percent interest are having trouble keeping up with loans that have interest rates twice as high.

Who’d a thunk it?

Now, are talking about $25 billion in subprime auto loans. Will Uncle step in – once again – and bail out the shysters issuing these loans with more of our money?

Of course he will.

Spending other people’s money is not only what Uncle does best – it’s all that Uncle does. He hasn’t got a penny of money that’s not been taken from others first. Why not be generous? There’s always more where that came from.

But this rant is not primarily about Uncle and his bottomless generosity with other people’s money.

It’s about what the bubbling trouble in the subprime auto loan mark says – canary in the coal mine-wise – about the health of the car industry generally.

Consider:

If – as the numbers suggest – more and more people are having trouble getting conventional car loans, either they are uncreditworthy or cars are too expensive for them (relative to income).

This latter thing is the canary in the coal mine.

A few weeks ago, I wrote about the average price paid for a new car last year – about $32,000 – a record high. And about the corollary to this: The ever-increasing duration of new cars loans. They are now on average six years long – and seven year loans are becoming pretty common. In order to spread out payments (now averaging almost $500 a month) that have become simply too much to manage for most people.

All these things are canaries in the coal mine.

And the canary’s looking woozy.

Even a slight upticking of interest rates will send him toppling off his perch, to land lifeless on the newspaper below. The private banking cartel that manipulates the American economy for its benefit – you know, the “Federal” (like “Federal” Express) Reserve  – has been threatening to raise the cost of money (interest) for some time now. The only thing holding it back has been flaccid spending, a general reluctance on the part of the public to buy stuff with money they haven’t got.

Which includes cars.

There was a time – within living memory – when you didn’t have to hock yourself to a six or seven year loan to be able to drive home a new car car.

Many people paid cash.

Today, almost 90 percent of all new car “sales” are financed.

And more than 55 percent of used car “sales” are financed, too.

The Fed has been attempting to “stimulate” (false) demand by tempting people with low-cost money (i.e., low interest rates) and that is probably the main thing propping up demand for new cars – much in the same way that artificial demand for homes was confected by the very same Fed.

Especially given that Uncle succeeded in executing a kind of mechanical genocide of good (and affordable) used cars via the odious “cash for clunkers” program several years back.

There are not many serviceable used cars available as a result – and the ones that are cost a pretty penny.

Hence the need to finance them.

But the high cost of used cars plus low-cost (even “free”) money in the form of interest-free (or interest so low it pretty much tracks with inflation) loans on new cars makes it very tempting to sign up for a new car loan… even one that’s six or seven years long (about the same time as the typical indenture contract during the early colonial era, if you’re interested in a historical parallel).

But when, inevitably, the cost of money goes up – as it must if the private banking cartel is going to resume its profiteering – it will have the same effect on the car business as the same thing had on the housing /real-estate business.

Better grab hold of something.

The spreading evidence of a new round of subprime rot is just the beginning.

And it won’t be confined to just this one thing, either.

via Zero Hedge http://ift.tt/1WGbfJK Tyler Durden

Until recently, the bulk of the attention on the insolvent North American oil and gas sector fell squarely on the US. That is starting to change for two reasons: first, Canada’s regulator just ended the cute game (first profiled here) Canadian banks had been playing for years by reserving zero of their potential loan losses to the collapsing energy sector; second, slowly but surely Canadian oil and gas failures are starting to become a daily reality; failures such as that of Canadian junior oil and gas producer Terra Energy Corp which yesterday said it shut down production, ceased operations and announced the resignation of directors and officers on Monday, after its lender, Canadian Western Bank, demanded full repayment of its debt.

 

And that’s all it takes: one simple debt acceleration, which has led to the shuttering of Terra, and which would send thousands of insolvent energy companies into bankruptcy overnight. For now, most such insolvent companies continue to exist as zombies, many of which can’t even afford an interest payment, but which after the direct intervention of the Dallas Fed and the OCC (which as we exclusively reported bought the insolvent sector a brief reprieve when it demanded that banks not force debtors to repay) continue to exist as the Fed is terrified of the default tsunami that would be unleashed once the bankruptcies finally arrive, as they will.

As for the now defunct Canadian junior, according to Reuters, Terra, which was producing around 3,600 barrels of oil equivalent per day from its operations in western Alberta and north-eastern British Columbia, said that at current low oil prices the cost of operating was more than its revenue.

Oops.

Reuters adds that since September 2015, Terra has sold off around C$12 million in oil and gas assets to help pay down debt, but clearly the amount was not enough to cover all its liabilities.

Terra also said the asset sales in Alberta were hampered by the company having a liability management rating of below one – the ratio that regulators use to assess whether a company’s revenues cover the cost of fully reclaiming all its oil wells.

Liability management ratings and oil well liabilities are becoming an increasingly hot topic in Alberta, where lawyers have warned buyer concerns over reclamation costs tied to inactive wells are disrupting energy asset sales.

The company is the latest Canadian producer to fall victim to the prolonged slump in global crude prices.

This happened after one bank decided that throwing good money after bad is no longer feasible, no matter how much pressure US or Canadian regulators put on it, namely Canadian Western Bank, which served notice on Friday demanding repayment in full of the C$15.9 million ($12.18 million) owed by the company by March 28.

“The company’s lender has declined to provide further financial support to Terra and there is no other means of financing available to the company at this time,” Terra said in a statement on its website.

The ironic thing is that the lender knew the recovery on its loan will be negligible – if any – and yet it still pulled the plug, refusing to comply with the charade that “all is well” any more. According to Reuters, Canadian Western Bank has not announced a receiver to sell Terra’s assets. A source with direct knowledge of the matter said no receiver had been appointed because Canadian Western Bank is concerned the receivership process would not be worth the cost to the bank.

That’s right: the bank believes it would spend more on the process of liquidating Terra than it would collect in the end of the day.

“They are worried they will not find any (asset) purchasers because of economic and regulatory problems,” said the source, who declined to be named because of client confidentiality.

Canadian Western Bank declined to comment on the matter; after all what can it say – “we should have defaulted Terra much earlier when we still had a chance of recovering something?”

Prepare to hear this lament far more often in the future as banks ask themselves why they allowed zombie shale companies – like Terra – to pretend they are alive for as long as they have.

via Zero Hedge http://ift.tt/1S3Ulkc Tyler Durden

Submitted by Patrick Buchanan via Buchanan.org,

“Things reveal themselves passing away,” wrote W. B. Yeats.

Whatever one may think of Donald Trump, his campaign has done us a service — exposing the underbelly of a decaying establishment whose repudiation by America’s silent majority is long overdue.

According to The New York Times, super PACs of Trump’s GOP rivals, including PACs of candidates who have dropped out, are raising and spending millions to destroy the probable nominee.

Goals of the anti-Trump conspirators: Manipulate the rules and steal the nomination at Cleveland. Failing that, pull out all the stops and torpedo any Trump-led ticket in the fall. Then blame Trump and his followers for the defeat, pick up the pieces, and posture as saviors of the party they betrayed.

This is vindictiveness of a high order.

It brings to mind the fable of the “The Dog in the Manger,” the tale of the snarling cur that, out of pure malice, kept the hungry oxen from the straw they needed to eat.

Last week came reports on another closed conclave of the “Never Trump” cabal at the Army and Navy Club in D.C. Apparently, William Kristol circulated a memo detailing how to rob Trump of the nomination, even if he finishes first in states, votes and delegates.

Should Trump win on the first ballot, Kristol’s fallback position is to create a third party and recruit a conservative to run as its nominee.

Purpose: Have this rump party siphon off enough conservative votes to sink Trump and give the presidency to Hillary Rodham Clinton, whose policies are more congenial to the neocons and Kristol’s Weekly Standard.

Among the candidates Kristol is reportedly proposing are ex-Governor Rick Perry of Texas and former Senator Tom Coburn of Oklahoma, both respected conservatives.

Kristol contends a third-party conservative candidate can win.

He can’t be serious. It is absurd to think Gov. Perry, whose poll numbers were so low that he dropped out of the race last September without winning a single primary, caucus, or even a delegate, could capture the White House on a third-party ticket.

Perry would not even be assured of winning his home state.

Trump and Perry would split the conservative vote in the Lone Star State and deliver its 36 electoral votes to Clinton, thus assuring a second Clinton presidency. Does Perry want that as his legacy?

As for Coburn, he is not nationally known. But his name on the ballot would take votes, one-for-one, from the Republican nominee.

How would that advance the causes for which Tom Coburn has devoted all of his public life?

Indeed, if the supreme imperative for Kristol and the “Never Trump” conservatives is to defeat him, they have become de facto allies of George Soros and MoveOn.org, Black Lives Matter and Occupy Wall Street — and the party of Harry Reid, Chuck Schumer and Hillary Clinton.

However, if the oligarchs, neocons and Trump-loathers, having failed to stop him in Cleveland, collude to destroy the GOP ticket in the fall, they have a chance of succeeding. And Clinton’s super PACs would surely be delighted to contribute to that cause.

But, again, what will they have accomplished?

Do they think that Republicans who stay loyal to the ticket will not see them for the selfish, rule-or-ruin, wrecking crew they have become? Do they think that if a Trump-led ticket is defeated, they will be restored to the positions of power and preeminence that a majority of their fellow Republicans have voted to strip away from them?

The Beltway has to come to terms with reality. It has not only lost the country; it has lost the party. It is not only these elites themselves who have been repudiated; it is their ideas and their agenda.

The American people want their borders secured, the invasion stopped, the manufacturing plants brought back and an end to the conscription of our best and bravest to fight wars dreamed up in the tax-exempt think tanks of neoconservatives.

Trump is winning because he speaks for the people. Look at those crowds.

Establishment pundits are now wailing that they have gotten the message, that they understand that they have not been listening.
But still, they refuse to act on this recognition.

In June of 1978, Gov. Jerry Brown of California, who had fought tirelessly against Proposition 13, which would slash property taxes across California, did a U-turn when it passed in a landslide. And Brown himself implemented the tax cuts he had opposed.

He got the message and acted on it.

One sees none of this flexibility in the Beltway establishment, none of this acceptance of the new realities, only obduracy.

Donald Trump is only the messenger.

If these conservative defectors from a ticket led by Trump collude with Democrats, by running a third party candidate to siphon off Trump’s votes, they may succeed.

But they delude themselves if they think they will have solved the problem of their own irrelevance, or that they have a future.

The party will survive. They won’t.

via Zero Hedge http://ift.tt/1LEAIma Tyler Durden

In April of last year we said the ECB would soon end up buying corporate bonds.

We’re not sure if one year later counts as “soon” or not, but ultimately, we were proven correct when, earlier this month, Mario Draghi announced a new easing “package” that includes IG non-fin EU corporates as part of a plan to increase monthly asset purchases by €20 billion.

While our call may have been prescient given that it came 11 months ago and just one month after the ECB implemented PSPP, by the time this month’s ECB decision rolled around the market generally suspected that Draghi might take the plunge. After all, he massively disappointed in December and if the 5yr-5yr swap is supposed to be the benchmark by which success or failure is judged, well then there’s plenty more room to ease.

Just as there was no reason to believe the ECB would stop at sovereign debt when PSPP was launched last March, there’s no reason to believe Draghi will stop at IG debt going forward. There’s a kind of one-upmanship going on among DM central bankers and with his massive book full of Japanese ETFs not to mention his monetization of the entirety of JGB gross issuance, Kuroda is still the archetype against which all Keynesian craziness is measured. When judged against the BoJ, the ECB probably still has a ways to go before hitting the limits of central banker insanity and so, we think it’s entirely possible that Draghi moves into HY next.

But the reasons to believe Draghi will take the plunge into non-IG corporate credit go beyond the “MOAR is always better” line. As BofAML’s Barnaby Martin explains, the EU corporate sector’s penchant for bond buybacks may ultimately force Draghi further down the ratings ladder lest the ECB should end up entangled tender offers or else end up without enough debt to monetize.

*  *  *

From BofA

One issue that comes to mind with corporate bond QE is how will the ECB address the burgeoning theme of corporate debt buybacks? As chart 7 shows, European corporates have been pursuing bond buybacks rather than share-buybacks (that latter has proven underwhelming given tax issues and political pressure).

Bond buybacks by non-financials have been rising ever since the fourth quarter of 2012. In the second quarter of last year, €9bn of debt was tendered by non-financials (either outright or before the announcement of a longer-dated new issue).

What’s driven corporates to consider bond buybacks over more reflationary activities such as capex is, in our view, a combination of very high corporate cash levels (chart 9 shows that European corporate cash levels will increase by year-end to almost €450bn) and the zero/negative corporate deposit rates that are emerging across Europe (chart 10).

Rather than corporates suffering what we call “double taxation” (i.e. paying interest on debt obligations and paying interest on cash holdings), it has become more efficient for corporates to buy back their bonds. Added pressure has come from the rating agencies which have been motivating companies to refinance upcoming debt maturities ahead of time (especially when specific bond maturities are large).

We think this raises an important logistical point for ECB QE. If the ECB wants to avoid getting caught up in having to potentially make decisions on corporate tenders, then we think it may focus on buying bonds with maturities of 5yrs and higher.

But if we exclude 1-4yr bonds (chart 11) then this shrinks the ECB eligible universe from €550bn to only €361bn – just 22% of the true European IG credit market size.

If the ECB does not exclude the front-end of the credit market from their buying, then what will they do if corporates continue to tender for their bonds?

• If the ECB agrees to tender, then corporate bond buying could become a moving target for the central bank (their cumulative buying total would be subject to frequent falls).
• But if the ECB does not participate in tenders then they would be hindering the ability of European corporates to efficiently manage their balance sheet in a low interest rate world.

*  *  *

In other words, if the ECB intends to pull from the eligible pool of €550 billion in purchasable IG credit, they’ll have to risk getting themselves involved in tenders which, as BofA puts it, would create a “moving target” for corporate bond purchases. If the ECB buys in the 1-4 year bucket but refuses to participate in tenders, well then companies won’t be able to refi to take advantage of lower borrowing costs.

The only way to avoid having to make that decision is to stay away from the front end, but that reduces the universe of QE-eligible corporate bonds to just €361 billion, bringing us full circle to BofA’s conclusion: “…[this] potentially means that the ECB might have to consider buying BBs down the line.”

And just like that, the central bank dash for trash will be on.

via Zero Hedge http://ift.tt/1VAJ2FX Tyler Durden

Submitted by Nick Cunningham via OilPrice.com,

Oil prices have climbed by about 50 percent from their February lows, topping $40 per barrel. But the rally could be reaching its limits, at least temporarily, as persistent oversupply and the prospect of new shale production caps any potential price increase.

U.S. oil production has steadily lost ground over the past two quarters, with production falling more than a half million barrels per day since hitting a peak at nearly 9.7 million barrels per day (mb/d) in April 2015. American oil companies have gutted their budgets and have put off drilling plans, with many projecting absolute declines in 2016.

That has sparked a renewed sense of optimism among oil traders. Moreover, supply outages in places like Iraq and Nigeria have also knocked at least a quarter of a million barrels per day offline, an unexpected disruption that put upward pressure on prices in March. Geopolitical unrest still has the ability to influence prices, even while the world is awash in oil. More oil bulls are piling on in anticipation of the April OPEC meeting, on an unfounded belief that the production freeze may actually have any material impact on global oil supplies.

But while oil traders have found some reasons to believe that oil prices are rising, there are just as many, if not more, data points to backup bearish sentiment. Storage levels in the U.S. continue to set records, hitting 523 million barrels for the week ending on March 11. Until inventories start to deplete in a significant way, oil prices will face a lot of resistance trying to break above $40 per barrel. Iran also continues to add production, albeit at a slower-than-expected rate.

In fact, the rally to $40 was largely driven by speculation. As short bets peaked and started to unwind, traders closed out positions at a rapid clip, helping to push prices up by $12 to $13 per barrel in less than two months. The trend continued last week as hedge funds and other major money managers increased their net-long positions on crude by another 17 percent. Short positions are now at their lowest levels since last June.

But now, with oil traders taking the most bullish positions in months while the fundamentals still have not shifted in a correspondingly significant fashion, traders have set up the conditions where oil prices could snap back to the downside. Once it becomes clear that OPEC won’t come to the rescue, and traders have taken bullish bets to unwarranted levels, prices could fall back to the mid-$30s.

It isn’t just a speculator’s game, however. The physical market could change as well with oil prices as high as they are – shale drilling could comeback with oil prices at $40 per barrel and above. Some areas of North Dakota have breakeven prices at around $20 to $25 per barrel. Drilling for oil in shale is already a “short-cycle” event – a well can take weeks or months to be completed, whereas an offshore project can take several years.

On top of the quick lead times, U.S. shale companies are also sitting on thousands of drilled but uncompleted wells (DUCs). Over the past year, companies did not want to complete their wells and sell their output into a depressed market and/or they needed to save cash in the short-run so decided to defer well completions.

That means a wave of production, the extent of which is unclear, could come back online when oil prices prove enticing enough. Reuters cited a Wood Mackenzie estimate that found that the backlog of DUCs has already begun to decline, falling by about one-third over the past six months. In the Permian Basin and the Eagle Ford, more than 600 wells sit on the sideline awaiting completion, which could lead to the production of an additional 100,000 to 300,000 barrels per day. The backlog of DUCs should be worked through this year and next, returning to normal by the end of 2017.

"If the number of DUCs brought online is surprising to the upside, that means U.S. production won't decline as quickly as people expect," Michael Wittner, global head of oil research at Societe Generale, told Reuters. "More output is bearish.” Companies could even be forced to complete more wells in a rush to meet debt payments.

Neil Atkinson, head of the oil market division at the International Energy Agency (IEA), largely agrees with the potential shale restart. “If prices keep rising, we could find that because of the cost cutting and the technology improvements that some of this marginal production is switched back on,” he said in a March 18 interview with Fuelfix. “But how long does it take to reassemble crews, get the labor, the equipment and all the rest of it? This is what we don’t know.”

Baker Hughes reported that the oil rig count actually turned positive last week, rising by one to 387 (the overall rig count declined by four to hit 476, due to the loss of five natural gas rigs). Obviously, one data point does not prove a trend, but the dramatic declines in rig counts in 2016 have slowed and basically come to a halt in March. It is too early to tell, but drillers could begin to add more rigs if oil prices rise above various breakeven points. That is not good news for oil prices.

via Zero Hedge http://ift.tt/1LEuGSK Tyler Durden

It’s not the economy stupid… it’s USDJPY! When you absolutely need to maintain the narrative that the world is awesome, call Kuroda…

 

 

Come on Kuroda you can tractor it https://t.co/yw4dUwHrvh

— zerohedge (@zerohedge) March 22, 2016

 

Tick for tick…

Note the 3 failed momentum ignition efforts overnight.

via Zero Hedge http://ift.tt/1Rhm1ES Tyler Durden

The market reaction from last week’s dovish FOMC statement took many by surprise, including BofAML's HY Strategy team, but as they say the High-Yield Emperor has no clothes, warning that the underlying commentary provided by Chair Yellen shows the vulnerability for high yield issuers to longer-term growth trends. Couple the deteriorating fundamentals for HY issuers with downgrades outpacing upgrades by a ratio of 3.5:1 and a worsening of global growth potential, and they believe the recent rally, though boosted by strong inflows and cash generation, will ultimately fade.

Bad news is bad news, until it’s suddenly good

The market reaction from last week’s dovish FOMC statement took us by surprise. Due to risks stemming from global economic and financial developments, Chair Yellen kept the target range for the federal funds rate unchanged at ¼ to ½ percent. And although this outcome was largely expected by markets, the Fed also cited global growth concerns and subsequently reduced their growth and inflation forecasts for this year and next. Under normal conditions, the mentioning of global growth concerns by the Fed has been met with a market selloff as a negative economic outlook brings concerns of lower corporate earnings. In fact, the last two times the Fed indicated global risks to the domestic economy, while holding rates steady, high yield declined 4.5% and 4% over the next 13 days (Chart 1).

However, the prospect of lower rates for longer dominated investor sentiment in the 2nd half of the week, causing high yield to return 1.23% in just 3 days. While in the short term lower rates spells risk on and may be good for high yield, we believe the underlying commentary provided by Chair Yellen shows the vulnerability for high yield issuers to longer-term growth trends. Tighter financial conditions, slower global growth, and a strong dollar will all negatively impact future earnings from high yield issuers, in our opinion. And with ex-Commodities YoY EBITDA growth running negative in 3 out of the last 5 quarters (the worst in a non-recessionary period since 2000), we question how much further balance sheets can deteriorate before investors question the overall health of the high yield market. And as we discuss below, when looking at measures other than EBITDA, the fundamental picture becomes even less compelling for the asset class.

We also believe it is telling that bank stocks moved significantly lower after the rate decision. Though the price action in banks makes sense – a lower for longer rate environment reduces these companies’ net interest margin – typically the moves in bank equity and high yield spreads are very well correlated (-48%). In our view the challenging bank environment could be a canary in the coal mine for high yield. As financial volatility increases, bank earnings decline, and unease about the global economy heightens, banks pull back on risk and lending and the ability for corporates to access funding in times of need is compromised. Note the latest Fed survey on lending standards as a prime example of declining risk tolerance for loan officers.

Ultimately, we believe markets are currently responding to a major influx in cash and ignoring the fundamental backdrop for high yield- and this could continue for some time, likely until a negative catalyst takes the market lower. Case in point, in the past 4 months non-commodity spreads have been 85% correlated with crude oil prices (Chart 2). Such a high correlation suggests to us that investors have taken their eye off the ball with respect to non-commodity balance sheet health- something that is likely to lead to a surprise increase in defaults and negative price action later this year.

To this end, we wonder how long asset allocators will continue to focus too intently on transitory risk-on signals while ignoring the weak macro credit environment. Couple the deteriorating fundamentals for high yield issuers with downgrades outpacing upgrades by a ratio of 3.5:1 and a worsening of global growth potential, and we believe the recent rally, though boosted by strong inflows and cash generation, will ultimately fade.

Conviction tested, but not shaken

On November 24th, 2015 the opening paragraph of our Year Ahead report read as follows:

One year ago we wrote that 2015 would mark an inflection point for high yield; that there was a paradigm shift in the making that would alter the way high yield traded. This view led us to a bearish disposition for the year, one that we continue to maintain heading into 2016. In fact, as we re-read last year’s outlook, much of the same themes remain. Just like our position in late 2014 we make the case that Q1 next year will be seasonally strong, particularly with el niño creating a warmer weather pattern that will likely help the US economy. Coupled with higher than normal cash balances and a market that has sold off meaningfully in the back half of this year, we envision a scenario where accounts look to put money to work as they feel re-assured by seemingly underlying fundamental strength and optically wide spreads. To this point, we believe we could see high yield tighten beginning with the New Year, as the hope for earnings growth and the ability for leveraged credit to grow into its capital structure buoys demand for the product. We would not advocate buying but would take the opportunity to sell positions in crowded BB paper, accumulating dry powder for a better entry point later.

Although it took nearly 11 weeks to play out, our thoughts for Q1 now seem to be prescient, as the market is tighter on the year for the first time (1bp as of March 16th). As market participants we believe our job is not done well if every day we don’t test our thesis and conviction, try to find information that may change our view, and adapt appropriately. And there has been no time where we have done that more since the weeks following February 11th.

However, after digging into the macro and fundamental data, analyzing the technicals created by more easy central bank policy and breaking down our thesis as to why this is the end of the credit cycle and not some overblown year and a half selloff bound to snap back, we conclude that our bearish disposition for the remainder of the year remains just as well justified as late last year. In fact, although the rally we have recently experienced has been significant, at its basics the reasons for it are exactly what we expected when we wrote our 2016 outlook.

Bolstering our view that investors should not be lured into the temptation of throwing caution to the wind is that from our perspective, there still seems to be very heavy headwinds blowing directly into the path of the global and domestic economies. In fact, though the manufacturing and production portion of the economy appears to have bottomed out, the consumer now looks to be experiencing unexpected – if only modest so far – weakness. And as capital markets continue to remain challenging for the lowest quality issuers, we are concerned of the potential pitfalls of a tightening credit market in the context of a world where revenue growth and share prices were boosted by easy monetary policy and cheap debt. Although our economists wrote last week that they are not seeing signs of economic deterioration through the credit channel, we still worry that an elongated period of tight credit markets could ultimately weigh on hiring over the course of 2016 and 2017. And although it seems that for the time being investors are willing to overlook some signals suggesting a weaker consumer, we believe eventually renewed concerns of a global and US slowdown will overtake any reach for yield activity. Whether the concerns are justified or not is likely to define the shape of the cycle (slow and exaggerated, as the last 18 months have been, or shorter and steeper, as in 2009) but not whether the cycle has turned.

When fear turns to greed

Our economists believed in the beginning of the year that recession concerns were overdone. And although we are more bearish than they are on the longer term prospects of the economy, we agreed. The market clearly got ahead of itself in thinking we were currently in a recession or headed toward one within the next few months. However, we stress, it doesn’t take a recession to have bad markets (4.95% yields to 10% yields in 20 months can attest to that) and the study of recession probabilities should only be viewed in determining the shape of the cycle, not whether the cycle has turned or not. In other words, a recessionary environment is likely to bring a peak default rate while a non-recessionary environment is likely to bring exactly what we have experienced over the last year and a half: a rolling blackout. Not exactly a time period most credit investors will look back fondly upon and very reminiscent to 1998 – 2002.

Having said the above, we think it’s necessary to break down the economic data; not only to show that a) our economists were correct, but b) to show that markets have reacted just as irrationally on the way up as they did on the way down.

Digging into the details, BAML finds debt loads and impairments flashing bright red…

Not only has the ratio of tangible to intangible assets fallen markedly since 2013, but by further adding back “1-off” impairments to EBITDA, companies are inflating cash flow while also not taking into account the decreases in asset values that have direct consequences to the value of the firm. Because the ability of a company to finance itself through debt markets is (or at least should be) a function of the firm’s value in addition to its cash flow, the amount of debt a corporation has relative to its tangible assets becomes more and more important as the credit cycle wanes. In fact, as we are seeing from the commodities sector today, as well as some other idiosyncratic businesses that have recently run into trouble, debt to asset value is as important a measure as any when a firm realizes problems and needs to liquidate holdings. And the trend in total debt to tangible assets has been troubling, as companies have increased debt on asset values that have stagnated or begun to decline.

The increase in debt to tangible assets concerns us particularly when we see situations like Valeant Pharmaceutical, an example of a company where the value of its assets will prove pivotal to its ability to tap capital markets and ultimately service nearly $30bn in debt. The go-to story for Valeant has been the strength of its properties, namely Jublia and Bausch and Lomb, as the firm has been able to fall back on the idea that should its debt become too onerous, selling off assets to pay down a large capital structure would not be a problem. Should Valeant begin to write down some of the value of these assets, not only would these charges be added back to its Adjusted EBITDA, inflating its cash generation, but would also limit its ability to pay back its debt. Although just an example, this scenario can be applied to any number of companies in high yield. For this reason, as we look at tangible assets, impairment charges can’t be ignored when determining the underlying health of a business. And as we consider this crucial input that is often ignored by high yield investors, we see troubling signs of fundamental corporate deterioration as the amount of asset impairments to tangible assets (excommodity) for US high yield has increased sharply since reaching a low in March of 2015.

Which leaves BAML warning, "it's not a pretty picture"…

Bearing these assumptions in mind, when considering our universe of 397 high yield issuers we find that 79 or 20% of them are unlikely to generate enough cash to service their 2016 bond and loan payments, when also taking into account a company’s cash on hand. Expanding this analysis into 2017 and 2018, we find that 27% and 38% would potentially be unable to meet all upcoming debt maturities. While it is true that roughly 62% of these companies are commodity-related, that still leaves 14% of our ex-Commodity universe that absent asset sales or new debt financing would not be able to make all debt payments between now and 2018.

Of course, companies can find alternative methods to generate liquidity such as accessing the capital markets and selling assets on their balance sheet. However, if all companies were to sell 20% of their tangible assets at 75% of book value, 6% will still have negative cash generation by the end of 2016 and 27% by the end of 2018. What’s more, given the constant need to invest and grow through capex, likely requiring investment rather than divestiture, any company that is forced to sell 20% of the assets on its balance sheet to meet debt obligations will simply be kicking the can down the road and eroding bond holder value. Though negative cash flow is in and of itself not a reason for default, and in fact many companies for a variety of reason chose to run their business negative for a period of time, in an environment where asset values are declining and access to capital markets is difficult, we think the large negative numbers could be concerning. Given the high percentage of companies continuing to burn a quickly diminishing stockpile of cash, we believe investors should be more concerned about the possibility for significantly wider spreads on new issue (and hence secondary paper) as investors allow the firm to buy time so they can realize the value of the assets, or at worst, end up in default.

via Zero Hedge http://ift.tt/1LErA10 Tyler Durden