Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

Many investors blame the escalating weakness in corporate credit on falling commodity prices. But that’s only one piece of the story, one that ignores a collapsing credit cycle amid a much broader global slowdown.

Standard & Poor’s said on Tuesday that the outlook for corporate borrowers worldwide was the worst since the global financial crisis, with potential corporate downgrades outpacing possible upgrades by the most since 2009. This has been attributed largely to slower growth in China and a commodity rout that’s cut prices to the lowest since 1999.

Low on Energy
Junk-debt buyers are demanding the biggest premium ever to own energy-related debt compared with the broader market.
Source: The BofA Merrill Lynch US High Yield Index

In reality, the pain goes well beyond that. Industry sectors representing about 70 percent of the high-yield bond market have more than 10 percent of bonds trading at distressed levels, Deutsche Bank analysts Oleg Melentyev and Daniel Sorid said in a Jan. 8 report. That includes technology, media, consumer products and casino-operating companies, not just oil drillers and miners.

The ratio of deeply distressed bonds, or those yielding 20 percentage points more than benchmark rates, has continued to increase, reaching 8.8 percent for all high yield and 4.2 percent for the market excluding energy companies, the analysts wrote. This ratio is tightly correlated to default rates and points to an escalating number of insolvencies across a variety of industries.

But here’s the catch: Investors largely seem to think that they’re insulated from losses if they stick with higher-rated junk bonds of companies, especially those outside commodities-related industries. Evidence of this can be found in the fact that the lowest-rated junk bonds are yielding the most since 2009 relative to higher-rated speculative-grade bonds.  This logic is faulty.

Premium Premonitions
The lowest-rated U.S. junk bonds yield the most since 2009 relative to higher-rated notes.
Source: The BofA Merrill Lynch US High Yield Index

Last year’s 4.6 percent loss on U.S. high-yield debt was not due entirely to falling oil prices. Yes, crude values have plunged to the lowest since 2003. And yes, Wall Street analysts forecast more losses ahead.

This, however, is not the sole cause of the debt-market turmoil. Over the past eight years, companies have borrowed trillions of dollars from investors who were eager to fork over their money for record-low coupon payments. That time has come to an end as the Federal Reserve starts tightening monetary policies, and debt buyers are demanding higher yields and more concessions from companies.

The $1.3 trillion U.S. high-yield market has started shrinking. Companies sold $284.8 billion of the debt last year, the lowest annual issuance since 2011 and down from $363.6 billion in 2014, according to data compiled by Bloomberg.

If companies can’t demonstrate success in a new world of less-forgiving lending standards, than it’s going to be harder and harder for them to survive. This goes for companies from Claire’s Stores to Sears to iHeartCommunications, not just all those energy companies that went on a borrowing binge on the heels of easy-money policies, only to have that backfire along with declining oil prices.

It’s not a good idea for debt investors to dismiss credit weakness purely as fallout from a busted commodities bubble. It’s more than that. It’s the end of a cycle and the beginning of a normalization of markets that are still bloated relative to history.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net