As we’ve pointed out on a number of occasions, there’s been no shortage of corporate debt issuance this year as high grade supply in the US hit a record $348 billion in Q1 helped by a blockbuster month in March which saw $143 billion in deals price. Meanwhile, high yield issuance came in at more than $90 billion for the period. Despite goldilocks (to use a financial market cliche) conditions characterized by the interplay between yield-starved investors, rock-bottom borrowing costs, and companies’ propensity to leverage their balance sheet in order to inflate earnings and underwrite their stock price, at least one leading indicator is flashing red.
As UBS notes, trade credit indicators are now at their worst levels since the crisis and unfortunately for anyone piling money into junk bonds, tightening conditions in the financing of receivables and inventories turns out to be a very good predictor of where HY spreads are headed. Here’s more:
Credit is the lifeblood of the world economy, and we believe the retrenchment of lenders from extending new credit is a highly reliable leading indicator of future problems for borrowers and the economy at large. Lending conditions have hitherto remained acceptable, particularly in the IG & higher quality HY bond market, where issuers are churning out debt in near record amounts. However, recent monthly surveys from the National Association of Credit Management’s Credit Managers Index (CMI) paint a picture in stark contrast. Simply put, measures of trade credit (the financing of receivables and inventories) have deteriorated sharply from January to March and are at their worst level since the financial crisis. We believe this data point should not be dismissed, and is an indication of the negative credit ramifications from dollar strength and falling EM demand.
The CMI polls 1,000 trade credit managers across the US and asks respondents to qualitatively assess changes in lending conditions from prior months. The index constructed is a diffusion index, similar to PMI indices (any readings greater than 50 indicate an economy in expansion, any readings less than 50 indicate an economy in contraction). The index is split evenly between service and manufacturing firms, so it will pick up conditions impacting both domestic and international borrowers. The survey covers credit managers at companies and finance firms, rather than from banks.
The latest March survey indicates sharply deteriorating conditions, which is a problem for credit investors, as the CMI has been a leading indicator of HY credit spreads in the past. Much of the weakness is being driven by lenders, rather than solely a tick-down in borrowing demand. The amount of credit extended fell precipitously and the number of credit applications rejected by lenders increased sharply last month. Dollar amounts beyond terms (the length of times it takes customers to pay) and dollar amounts of customer deductions (which measures the cash flow problems of customers) are also in contractionary territory. New credit applications did increase, but this is not necessarily a mitigating sign. It may indicate that stressed borrowers are reaching for a lifeline and getting rejected. This was seen during the financial crisis when demand for trade financing increased even as banks cut supply.