Deutsche Bank Says World "Past The Point Of No Return" In The Default Cycle

Tyler Durden's picture

Over the past year, the credit cycle finally turned, and has unleashed the latest default cycle. In fact, as BofA's Michael Contopoulos warned last week, it may be the worst default cycle in history with "cumulative losses over the length of the entire cycle could be worse than we’ve ever seen before."

Over the weekend, the FT got the memo with a report that "global company bond defaults at highest level since 2009" in which it said that "the global bond default rate by companies is running at its highest since 2009 with the US accounting for the vast majority, according to rating agency Standard & Poor’s. A further four defaults this week, with three coming from the troubled oil and gas sector, pushed the overall tally to 40 with a little over a quarter of 2016 done."

To be sure, the US default cycle is bad and getting worse. But how much worse?

The latest to attempt that answer is DB's Jim Reid who in his just released 18th annual default study explains why his "late cycle fears continue to build." These are some of the highlights:

There are clear signs the cycle is turning, especially in the US. Our US strategists have previously suggested that we need the combination of three conditions for us to be confident the next default cycle is imminent. We need the accumulation of excessive debt and preferably of deteriorating quality, some kind of external shock/trigger and tighter monetary policy/a flattening of the yield curve. The pieces of the jigsaw are building. US corporate debt accumulation now compares with that seen prior to previous default cycles. Equity volatility has seen two spikes in the last 12 months (August and early 2016), bank equity is falling (a lead indicator of lending?) and global yield curves continue to flatten.

* * *

The buildup of excess is often a pre-requisite for bubbles to burst or for economic cycles to be vulnerable to shocks. One argument for why this US economic cycle might still be able to run for a few years is that many economists feel that excess hasn’t been as prevalent as in prior cycles. However one can argue there has been a sizeable increase in US corporate debt since the GFC comparable to increases prior to previous default cycles. As Figure 15 shows, in the modern era of leveraged finance the debt cycle waves have been well correlated to defaults. We’ve used single-Bs to keep credit quality constant throughout and used Fed data to determine non-financial corporate debt/GDP.



Our US credit strategists measure the total growth of debt stock as well as its aggressiveness to determine whether there has been sufficient “material” created to feed the next wave of defaults. Figure 16 looks at the growth of the stock of US HY debt as well as the aggressiveness of new issuance. The former is measured by the combined size of the HY bond market (USD developed markets) and loans on U.S. bank balance sheets. The graph shows distinct periods of debt growth in the past, going back to the late 1980s, with each of the past three complete credit cycles preceded by waves of new debt creation, lasting from four to five and a half years, and resulting in cumulative debt stock growth of 53-68% (shaded areas). The current episode, measured since early 2011, has lasted 5.2 years and resulted in 64% growth in the combined value of the high yield bond market and loans on bank balance sheets, putting it comfortably inside the range of previous cycles. It shows a similar result to our own US corporate debt/GDP chart.



For a measure of aggressiveness in recent issuance trends, our US strategists look at CCC-rated issuance in HY and leveraged loans, as a percentage of total  market size, as shown in the right-hand graph of Figure 16. Volume is presented as a percentage of total market size (HY + loans), on a trailing-12- month basis. Shaded areas again highlight previous debt growth cycles, as well as the most recent one, with figures printed inside representing cumulative CCC issuance volume for the full duration of each episode, divided by the market size at its start. The previous two credit cycles, in the late 1990s and mid- to late 2000s, saw this indicator expand by 20% and 18%, respectively, compared to its present value of 17%. Unfortunately, there is a lack of detailed issuance data to extend this to the first cycle in the late 1980s.


The analysis is somewhat conservative in estimating the starting point of the current credit cycle to be January 2011. Arguably, the market was healing and perhaps even expanding in 2010, which would make these measurements of pre-requisite debt growth and aggressiveness look even more stretched here. We will nonetheless use the numbers shown above, as we aim to build our case for the timing of the next default cycle based on the more conservative assumptions.


We can therefore conclude that pre-requisites for the next default cycle are now in place.

From the conclusion:

The artificial ingredients keeping defaults below their 1983-2003 levels are still broadly in place so although we expect the next default cycle to be round the corner it could still be mild relative to the early 90s and early 00s cycle and even the already subdued 2009 cycle which was very short, especially given the economic wreckage seen.


As we’ve suggested in previous editions of this report, this is likely due to the increasing artificial demand for fixed income seen over the last 15-20 years which effectively allows more financing opportunities for levered companies at lower yields than they might be asked to pay if global fixed income markets were a perfectly free market where the only consideration was relative value. Over the last two decades, SWFs, pension funds, insurance companies, banks and more recently central banks in great size have distorted the demand for and yield of global fixed income. This is unlikely to change and although the Oil and Gas sector demonstrates that bad fundamentals can still win out, for more marginal companies, the artificial conditions in fixed income could still help prevent a more savage cycle.


Obviously the Oil and Gas sector will play a big part in determining the overall level of defaults and in a separate section our US strategists detail their expectations for defaults in this sector and how that will filter through into the wider US HY market.


It’s also true that credit spreads are relatively elevated and price in a default rate markedly higher than current levels. Indeed as we’ll see throughout the body of this report, at an aggregate level a buy-and-hold investor would need to see defaults worse than virtually all observed periods through history for them not to get a positive excess return relative to Government bonds from this starting point. However if we do see a recession even if defaults are relatively subdued the illiquidity of financial markets could easily see big mark-to- market losses. Recession tend to bring big overshoots in credit spreads relative to default risk anyway. So lower structural defaults may not provide comfort in the heat of the next recession but current spreads should give longer-term investors some comfort across the vast majority of sectors.

All of which perhaps explains why the ECB is well on its path to monetizing junk bonds once it is done with investment grade corporates.

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brada1013567's picture

Don't worry, everyone will be bailed out.

stocktivity's picture

Nothing to see here...move along....futures are way up.

Bastiat's picture

Translation:  DBank is past the point of no return.

JRobby's picture

Who are their counter parties? (Laugh Track Deafening!!!)

Bailouts for all!!!!!!

ebworthen's picture

Banks will be, regular folks given cents on the dollar, or nothing.

Theonewhoknows's picture
Theonewhoknows (not verified) ebworthen Apr 11, 2016 7:46 AM

They will print enough money to bail banks out - but this will eat everyone else in the process. Especially when 3 Italian banks are failing hard and Deutsche Bank’s (the biggest bank in Europe) exposure in derivatives (things that caused 2008 meltdown) is now equal to 10x Eu’s GDP.
They will need war on cash to continue their socialist, centrally planned solution in place – what is happening economically in the Continent is unbelievable

wmbz's picture

"Deutsche Bank Says World "Past The Point Of No Return" In The Default Cycle"


No shit! Really!  You guys are right on top of things.

Who could have figured that out besides some bankster douche bag.

Fucking morons.

factgasm's picture

It's no coincidence that Douche Bag and Deutsche Bank sound so alike.

SomethingSomethingDarkSide's picture

I've got a Raging Clue about Miner Stocks

Ghostdog's picture

They should know since they will be the first to default

Bay of Pigs's picture

The size and scope of the fraud ridden pig of Douche Bank is something to behold in itself.

Cautiously Pessimistic's picture

Some folks over at Deutsche Bank peddling that fiction. 


adr's picture

And just like the past seven years, the worse the news gets the higher stocks go.

Why not send oil back to $100 on the news.

What we haven't passed is the Tribe supercycle. We are at peak Tribe right now.

JRobby's picture

Sending oil back to $100 is very easy for them to do. They got it to $128 when the real market was $70 to $80.

No, no, no they are not letting Russia up off the mat.

slaughterer's picture

DB is past the point of no return in its own default cycle.  There, fixed it.  

williambanzai7's picture

Thay are coming in for a very hard landing and this time the German taxpayers will have to do the bailing.

Sandmann's picture

German taxpayers are tapped out. Maybe the 1% can stump up but Otto Normalverbraucher has no money.

williambanzai7's picture

Will this interfere with the funding of President Limp Nuts Library Plans?

And fuck Douche Bank!

JRobby's picture

I hope they are putting in a huge grease trap?

slaughterer's picture

Wonder what US bank will get to buy the dead douche for $2/share next weekend.  

o r c k's picture

Like the burn patient said : Better default than debride.

Sandmann's picture

Funny how hard they have worked to prove Karl Marx right  - they have commoditised production and labour and have now destroyed money the whole basis of the Cash Nexus.

Goldbugger's picture

I wonder what DB's derivative exposure is?

Kefeer's picture

Does it matter; if DB were to be the next Lehman, then it would be of a magnitude of 50X greater and since all the large banks are knit together it is all for one and one for all.  DB will not fail unless they all fail and that doesn't happen until the highly evolved money changers decide it is best for the purging of the "lessor herd".  All for the good of mankind and the planet - go elitist!! Go Darwin!! Down with Jesus!!  Down with righteousness!!   In with the the religion of secular humanism!!

Davilis's picture

Ha ha ha, that headline should read "DB's world is past the point of no return, predicts it's own default"


Defaults will surpass all other periods and once again Douchewhore Bank is literally incompetent in terms of long term expectations as usual.


die die die Douchebagscum Bank

conraddobler's picture

This is assinine for no other reason than there is no earthly mathematical reason why we have to perpetuate a system that is so archaic that it forms predictable booms and busts.

Debt based money will ALWAYS do this.

There is zero need to base money on debt.

Borrowing should only be done for productive reasons and very sparingly.   

Buying a truck that can be put to use to extinguish it's own payments with increased production is one example but borrowing to jigger a balance sheet and take on cheap debt to increase bonuses is NOT a productive use of debt and it's extremely risky.

The costs of this system are epic in terms of human suffering and misery yet it's all we know and we act like it would be akin to aliens landing on TV to contemplate anything else.

This is not congruent with our other technological advances.