Yves here. Recall that there was a huge buyout boom in 2006 and 2007, and ratings agencies were predicting a refinancing train wreck in 2014 to 2014. That didn’t happen due to QE and ZIRP. This refinancing bulge is more compressed in time and more imminent.
By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at http://wolfstreet.com/2016/02/12/how-financial-chaos-begins/“>Wolf Street
Most of the defaults, debt restructurings, and bankruptcies so far this year and last year were triggered when over-indebted cash-flow negative companies could not make interest payments on their debts.
During the crazy days of the peak of the credit bubble two years ago, they would have been able to borrow even more money at 8% or 9% and go on as if nothing happened. But those days are gone. Now the riskiest companies face interest costs of 20% or higher – if they’re able to get new money at all. Hence, the wave of debt restructurings and bankruptcies.
But that’s small fry. Now comes the wave of companies whose debts mature. They will have to borrow new money not only to fund their interest payments, cash-flow-negative operations, and capital expenditures, but also to pay off maturing debt.
That “refinancing cliff” is going to be the biggest, steepest ever, after the greatest credit bubble in US history when companies took on record amounts of debt, and it comes at the worst possible time, warned Moody’s in its annual report.
In its report a year ago, Moody’s had already warned that the refinancing cliff for junk-rated US companies over the next five years – at the time, from 2015 through 2019 – would hit $791 billion. Of that, $349 billion would mature in 2019, the largest amount ever to mature in a single year.
But Moody’s pointed out that “near term risk remains low as only $18 billion, or 2% of total speculative-grade issuance comes due in 2015.” And that’s how it played out last year.
Since then, the refinancing cliff has gotten a lot bigger, according to Moody’s new annual report. The amount in junk-rated debt to be refinanced over the next five years, from 2016 through 2020, has surged nearly 20% to a record of $947 billion.
This is an increasingly steep cliff, with the largest portions due in the later years of the period, including $400 billion to mature in 2020, the highest amount of rated debt ever to mature in one year.
And near term? Moody’s Senior Analyst Tiina Siilaberg warned that there would be “a significant wave of new issuance in late 2016 and 2017.” At the worst possible time – because “a range of macroeconomic factors will make it more difficult for lower-rated companies to tap the debt capital markets in order to refinance their debt obligations.”
One of those macroeconomic factors is the spread between yields of these lower-rated junk bonds and Treasuries, which has totally blown out. For debt rated CCC/Caa1 or lower, the average spread has shot to over 20%, where it had been on October 6, 2008, right after the post-Lehman panic. And yields for these bonds have soared to over 21% on average.
Among the other macroeconomic factors, Moody’s lists the slowdown in China and volatility in oil prices. And there’s another factor that will “make it more difficult for lower-rated companies to refinance”: worried regulators have been cracking down on banks’ exposure to leveraged loans, which are so risky that even the Fed has been fingering them publicly.
Banks sell these leveraged loans to loan mutual funds or repackage them into collateralized loan obligations (CLOs) which they then sell in tranches to institutional investors. When leveraged loans mature, companies have to come up with the money, but Moody’s warns that “rising defaults and the impact of the Dodd-Frank Act’s risk retention rule will make it more difficult for existing CLOs to supply corporate financing.”
This leaves Moody’s refinancing index, which measures if there’s sufficient liquidity in the credit markets to deal with the refinancing cliff, at “2009 levels,” which indicates “that the refinancing conditions are weaker than normal,” said Moody’s in its laconic manner.
And the refinancing cliff is getting bigger: In the current downgrade tango, companies at the lower levels of investment grade are getting downgraded one or two notches and end up with a junk credit rating, thus increasing the total amount of junk-rated debt that needs to be refinanced over the next five years beyond the $947 billion.
The telecommunications, technology, and media sectors are weighed down by the highest debt burden. But as energy companies and much of the remaining commodities sector have gotten run over by the commodities rout, their credit profiles have sharply deteriorated. And a number of these companies at the lower levels of investment-grade will likely be downgraded into junk.
For example, energy companies that Moody’s still rates Baa3, so one notch above junk, have $34 billion in debt maturing over the next five years. “But there is a high risk that investment-grade issuers in these sectors will be lowered to speculative-grade,” Moody’s said.
This trend has been playing out in Moody’s Liquidity Stress Index, where the energy sector continues to fuel liquidity downgrades and defaults. These companies are already grappling with cash flow constraints, and they will be tapping the markets just as increased regulation and slowing growth in China make the credit markets more risk-averse.
But it’s not limited to energy and commodities. Other companies in sectors like brick-and-mortar retail, restaurants, or telecommunications (Sprint is the biggie here) are heading down the same path toward the cliff. And when these companies can’t refinance their maturing debts, they go over the cliff – or rather their stockholders and creditors will go over the cliff.
So it’s not contained. Read… This is How Financial Chaos Begins
Typo above article in Yves’ note. It says 2014 to 2014 when it should be saying 2014 to 2015 or something.
My guess is that we are being overly credulous about “market forces” and all that guff–if the government and the financial industry wants these firms to survive (can anyone say the bankrupt frackers) the money will be found to keep them afloat. Things seem to get out of hand when enough businesses and individuals who lack political clout or connections are revealed to be in big trouble and panic ensues. If the fixers in the system have the time and the heads up early enough then things will get done to make sure the insiders are taken care of in time to avoid a rout. When the Fed and the Treasury can create money from nothing with little to no threat of inflation ensuing (because the money doesn’t circulate, it just gets syphoned off by the investor class and sits idle in the Cayman Islands) then situations that the textbooks tell us should precipitate a crisis will not precipitate a crisis unless somebody screws up or is asleep at the switch.
Speaking of junk finance, whatever happened to all that commercial real estate and muni bond junk that was supposed to hit the scrap pile post 2008? Part of the 5 year credit re-fi boom too?
Probably, as Yves said in reference to the article, QE and ZIRP allowed them to stay afloat until now. Not sure if it’s included in Wolf’s figures, but I’m sure commercial and munis are also going to be in trouble. Lots of empty commercial property, at least around south Alabama, and many, if not most, states are giving big tax breaks to lure new industry and reducing tax rates at the top end, which, of course, reduces the available revenue to pay off their bonds. Between the overall macroeconomic stagnation and the vast range of overvalued assets due to ZIRP, etc., I see a bloodbath coming in the asset markets, including stocks, bonds and real estate. (Commodities have already tanked.)
I see this debt cliff as a neoliberal blowback. You see, an effective CEO does all he can to juice shareholder value, often measured quarterly. So, with lagging sales and low or no profits, many chose to borrow money to increase shareholder value by buying back stock, thereby increasing share price, or juicing dividends. After all, they had the cashflow to pay the interest and huge hopes for the future. If instead, CEOs were more concerned with the long-term vitality of their company they would have trimmed production and shaved costs wherever they could, including reducing C-suite salaries. Had the major oil companies done such things, they could today be gorging on the distressed wildcatters instead of worrying about managing their debt.
Helpful tip – when ever using the meme ‘shareholder value’ follow in brackets [bonus multiplier].
Skippy…. I also like the ‘short skirt’ come hither juicing dividends thingo… why – as you say, administer a company when all you have to do is prance around with money falling out your lingerie on the exchange dance pole….
Hmmm…it seems to me our financial system is based on the old “Run for your Life” TV show.
For you youngsters, this is where a handsome guy finds out he is going to die, so he decided in his last year (this is in TV time, so if the series went for years it would not have been a problem) that he would live it up.
Now, how does he pay for all these adventures?????
Simple – Credit
American express bill is charged to his diners club and than the diners club is charged to Master Card, and so on. And of course, as he is “paying” ever bigger bills, he is advanced ever more credit….deja vu all over again…
Of course, the TV protagonist had a way to escape all his debt….