Junk Bonds Are in Worse Shape than Before Lehman Collapsed

Percentage of S&P junk bonds and leveraged loans considered "distressed" (click to enlarge)

by Gaius Publius

We know that there will be another economic "big one" like the crisis of 2008. All of the pieces are in place — Wall Street greed and literal pathology, the even greater size of too-big-to-fail institutions, a literal get-out-of-jail free card that almost blesses continued financial fraud, and the like. We just don't know when it will occur, or what will trigger it. Last time it was triggered by the collapse of the bubble-sized home mortgage market. The time before that, it was the bubble-sized tech stock valuations. Where's the bubble now, or the inverse bubble, the market hole that may be forming somewhere?

Many people are looking at collapsing oil prices and soaring supplies, which is causing the collapse of over-leveraged carbon companies of all types (coal, oil and methane), as a potential cause of the next crash. Others say that the collapsing price of oil is "contained" — unique and isolated — and is not contaminating other markets.

The following piece by Wolf Richter argues the opposite point — that the collapse in the carbon market is not contained at all, and that collapse is in danger of spreading via the increasing price of junk bonds. Is this a precursor to the next "big one"? See what you think.

Wolf Richter (my emphasis throughout):

Now It’s Even Worse Than it Was When Lehman Collapsed, But It’s “Contained”

“Distress” in Bonds Spirals into Financial Crisis Conditions

The pile of toxic corporate bonds in the US, euphemistically called “distressed” debt, ballooned 15% in the single month of February to $327.8 billion, up 265% from a year ago, according to S&P Capital IQ. The number of S&P rated US companies with distressed debt rose 9% in February to 353, up 128% from a year ago.

The last time the pile of distressed debt had soared to this level was in November 2008, and the last time the number of distressed issuers had shot up to these levels was in October 2008; Lehman had declared bankruptcy in September.

These “distressed” junk bonds sport yields that are at least 10 percentage points above US Treasury yields, according to S&P Capital IQ’s Distressed Debt Monitor. 

Note the definition in the final paragraph above. Bonds are considered "distressed" if they have to offer 10 points or more greater yield than U.S. Treasuries in order to attract buyers. Obviously, any company whose financing depends largely on these bonds is at risk of bankruptcy.

As a chart, the above data looks like this. Take a minute to study it.

The Y-axis is both number of issuers (bar graph) and billions of dollars issued (line graph). Click to enlarge.

Richter adds this about the S&P "distress ratio" for junk bonds and leveraged loans (see chart at the top):

The ratio hit the highest level since July 2009, when it was coming down from the Financial Crisis. But this is the spine-chilling part: Back in September 2008, before the Lehman bankruptcy had fully registered in the ratio, but when the Financial Crisis was already gaining a good amount of momentum, and when stocks were crashing left and right and prudent people were wearing hardhats while out on the sidewalk, the distress ratio was “only” 28.9[.]

Richter quotes the report he cites as saying that a rising ratio is “typically a precursor to more defaults.” If he's right, we could be headed into the same soup we took years getting out of. And this time, it will be a political soup as well, since the country, both left and right, is in zero mood for another massive government bailout.

Not Confined to Oil and Gas

Nor is the damage in these markets confined to the carbon sector. Richter again:

And it’s not just the oil-and-gas and the minerals-and-mining sectors that are getting crushed. Of the 607 distressed bond issues in the ratio, 172, or 28%, are oil-and-gas related and 80 bond issues, or 13%, are minerals-and-mining related. The remaining 59% are spread across other the spectrum.

“Spillover effect,” is what S&P Capital IQ calls this. It has contaminated “the speculative-grade spectrum as a whole.”

The article has more along these lines, including a list of sectors affected, how many billions of dollars in debt are distressed in those sectors, and the main companies affected in each sector. It's quite eye-opening.

Will Commodity Prices Cause the Next Collapse?

I've been personally watching all of this with interest. There is a bubble in commodities — especially those things that the very very wealthy are interested in (for example, Manhattan real estate and high-end art) — but really, in commodities in general. There's also a major crack in the commodities bubble connected to carbon products (coal, oil and methane). I've wondered before if collapsing oil prices would spark a collapse in other commodities (stocks, for example) via the highly leveraged, and therefore highly vulnerable, nature of many fracking companies in the U.S.

It's possible we'll get an answer soon ... or not. Still, this is worth watching. If you're interested, Richter's website, Wolfstreet.com, is worth checking on a regular basis.

GP