S&P Warns Removal Of "Easy Money Punch Bowl" May Trigger Next Default Cycle

Stocks aren't the only losers from the recent spike in yields: according to a new note out of Standard & Poors, record corporate leverage and rising interest rates could lead to a potentially explosive cocktail, one in which the removal of the "easy money punch bowl" could trigger a wave of corporate defaults.

The combination of easy liquidity coupled with lax underwriting standards, a yield-starved buyside, record number of covenant-lite deals and low interest rates have contributed to a spike in the number of highly leveraged firms, creating a risk "masked" by relatively low default rates, Bloomberg writes. As Goldman first pointed out last summer, even as corporate defaults remain near historically low levels, froth "has been building in the form of corporate leverage. While this may not present a near-term risk, the widespread increase in debt resulting in stretched leverage metrics bears watching, in our opinion."

Fast forward to today when S&P analysts caution that "despite a recent rise in corporate profits and financial metrics, the still high leverage of global corporates poses a significant credit risk."

Using a global sample of 13,000 entities, the rating agency estimated that the proportion of highly leveraged corporates - those whose debt-to-earnings exceed 5x - stood at 37% in 2017, compared to 32% in 2007 before the global financial crisis.

Furthermore, over 2011-2017, global non-financial corporate debt grew by 15 percentage points to 96 percent of GDP.

"On average, corporates are at the top of the credit cycle. Lower asset prices and liquidity reversals are major risks," S&P wrote.

And the punchline: "Removing the easy money punch bowl could trigger the next default cycle since high corporate debt levels have increased the sensitivity of borrowers to elevated financing costs."

S&P then warns that the extraordinary post-crisis monetary stimulus created a gap between default rates, which remain low, and the number of highly leveraged corporates, which has surged as firms took advantage of easy liquidity.  This "masked" discrepancy between leverage and defaults is so wide that the recent pick-up in corporate earnings and financial metrics - especially thanks to tax reforms in the U.S. - “won’t be enough to offset” the significant credit risks, S&P said.

“When debt is this steep and default rates are low, something’s gotta give,” wrote the firm’s Terry Chan. "A material repricing in bond markets or faster-than-expected normalization in money market rates could impact credit profiles."

Terry is, of course, correct; the question is when does this repricing hit. The answer would be revealed in move of junk bond yields, and potentially market prices of tracking ETFs. Apropos, as Jeff Gundlach pointed out on Friday, the charts of the HY ETFs JNK and HYG - which are most sensitive to liquidity conditions for the most levered corporations - "look like death."

Should the recent selling in JNK and HYG continue, the tipping point which could result in defaults for over a third of the S&P universe of 13,000 companies may not be too far away.

Comments

Déjà view Dr. Engali Mon, 02/05/2018 - 22:23 Permalink

House Of ♣♠♥♦

Trump claimed that he dumped all of his stocks right before the Black Monday crash in 1987

"They told you so!" crowed the lede of a Wall Street Journal article the day after the crash, October 20.

"I sold all my stock over the last month," Trump told the Journal.

Trump also predicted terrible things ahead for the market.

"I think the market is going to go down further, there are just too many things wrong with the country," Trump said.

http://www.businessinsider.com/trump-sold-stocks-before-black-monday-cr

Do As I Say! Not As I Do!

In reply to by Dr. Engali

sheikurbootie Mementoil Mon, 02/05/2018 - 22:37 Permalink

Bitcoin was the stupidest "investment" I've seen since Beanie Babies.  What were the Bit Boys thinking?  Was Mt Gox not obvious enough? 

Typically, these suckers bought a small number on the cheap, rode the wave up, sold and then as it increased bought back in at a much higher price.  Now, they're stuck and losing everything plus more.  There is no falling knife, this is a fraud collapsing to zero.

In reply to by Mementoil

HRH of Aquitaine 2.0 Mementoil Mon, 02/05/2018 - 22:49 Permalink

I told everyone when I cashed out my original stake, had those funds sent to my bank, and left only profits in my GDAX account. My initial stake was around $500.

Today I put in a limit order to trade some of my BTC for LTC. Small portion. I said from the beginning it was an experiment for me. My point of view has not changed. It is still an experiment.

In reply to by Mementoil

sabaj49 Dr. Engali Mon, 02/05/2018 - 22:26 Permalink

since greenspan the fed has STOPPED every NORMAL business correction using some SPILL MORE MONEY INTO 1% money pit

please can we have BUSINESS CYCLE back were MAL-INVESTMENTS go bankrupt and the smart money comes into buy carcuss for pennies on $$$

then again then we'd have DEFLATION(ie making dollar more valuable) and we can't have that

In reply to by Dr. Engali

DeadFred Dr. Engali Mon, 02/05/2018 - 22:37 Permalink

Trump is playing 4D chess. It's not a coincidence this tank job happened right after the memo came out. My question for him is whether he has a plan for when the dollar dies. If he drains the swamp (and everything says he is) the FRN can't survive. What will take its place? You would be very wise in taking some long dated positions in PM's and even that Bitcoin stuff.

In reply to by Dr. Engali

TrustbutVerify Dr. Engali Mon, 02/05/2018 - 23:41 Permalink

Without Trump the markets would have likely fallen the day after the election and continued to fall.  In truth, the post election rally has been an "Obama's gone and Hillary didn't win" rally - with some added for Trump being elected and the tax bill being passed.  

At least, at this point, the fall has been only a percentage of the upward climb since his election.  

In reply to by Dr. Engali

TrustbutVerify Dr. Engali Mon, 02/05/2018 - 23:42 Permalink

Without Trump the markets would have likely fallen the day after the election and continued to fall.  In truth, the post election rally has been an "Obama's gone and Hillary didn't win" rally - with some added for Trump being elected and the tax bill being passed.  

At least, at this point, the fall has been only a percentage of the upward climb since his election.  

In reply to by Dr. Engali

JibjeResearch Mon, 02/05/2018 - 23:02 Permalink

No, don't stop this melt down...  Let it burns... Let it burns... to the ground

Bwahahh ahahahahaha ahahhahaha... 

So that the smarts can make more money

Bwahaha ahhahahaa.... 

 

No pussy in HS/College.... has its upside ahahaha ahahahahhahah

ilovetexas Mon, 02/05/2018 - 23:03 Permalink

By the way, who will remove the easy money? Which political system will tolerate the massive default like this? Maybe someday, like 1929. But is fed at peak craze? If not, they won't remove the easy money. No default!