Credit investors have spent the last few years suffering through isolated, industry-specific downturns.
First, it was energy, with more than 100 North American oil and gas producers filing for bankruptcy in the two years through 2016. Now there’s a good deal of pain being felt among bondholders of retailers, including Claire’s Stores, rue21 and Sears.
Next up, investors ought to prepare for some losses on bonds of telecommunication companies, including behemoths Verizon and AT&T.
These companies have spent the past few years packing on debt with record-breaking bond sales. Verizon and AT&T alone have raised a combined $107.5 billion in new debt since 2011, roughly doubling both of their long-term debt loads.
That in itself is cause enough to worry. But there are some fundamental reasons why this borrowing spree is going to end in tears for debt investors.
First, the four top U.S. sellers of cellphone service -- AT&T, Verizon, Sprint and T-Mobile -- are fighting one another for customers. That price battle has been great for people's budgets, but a downturn in average user bills particularly hurts Verizon and AT&T, which have the most wireless customers. Earlier this month, Moody's Investors Service downgraded its outlook on the telecom sector to negative from stable, citing the effect of price cuts on mobile phone companies' revenue growth and margins.
Second, the Federal Reserve has started raising benchmark borrowing costs from their all-time lows, which means it may only get more expensive for all companies to refinance their debt. So far, the $8.5 trillion U.S. credit market has largely taken the incremental rate increases in stride. But that could change, especially as many companies build their debt piles without significantly increasing their revenues.
AT&T Inc. and Verizon Communications Inc. are prime examples of this releveraging phenomenon. They have sold so many bonds that they have both been downgraded in the past few years and are now paying close to the biggest premium on record relative to similarly rated company bonds.
The more debt these companies have, the less they can afford to lose their investment-grade rating, which allows them access to much deeper, cheaper sources of financing than if they carried more speculative grades.
In fact, their bonds will most likely lose quite a bit of value if they are even downgraded to a lower investment-grade rating because so many investors own these bonds and will demand a hefty premium to take on any more. (See what happened to Sprint in 2015.)
AT&T is particularly at risk here because it will most likely be downgraded if the planned purchase of Time Warner Inc. goes through as proposed. AT&T's new debt is on track to jump by about $40 billion -- or 35 percent of the company's long term debt at the end of 2016 -- and adding Time Warner doesn't give AT&T a commensurate boost to its profits. Time Warner's annual Ebitda is roughly 16 percent of AT&T's yearly total.
Verizon doesn't have a huge acquisition on the table, but it is rumored to be hungry for one with cable company Charter Communications or satellite TV firm Dish Network. Verizon likely couldn't take on more debt to buy Charter, which has a stock market value of $100 billion.
There will come a tipping point at which the higher borrowing costs start eating into the companies' business model and dividends.
Stock investors aren't exactly complacent, given that these companies' shares have underperformed the Standard & Poor's 500 index. But they don't appear overly concerned either, with shares hovering near record highs.
Some bond investors are getting more worried. Carl Eichstaedt, a bond-fund manager at Western Asset Management, said he's bearish on the telecommunications industry generally.
"AT&T, Verizon, we're definitely short those names," he said in a Bloomberg Radio interview on Tuesday.
At some point, these telecom behemoths are going to have to prove they’re worth the money they’ve borrowed. This is similar to the fight that energy companies have struggled through since 2014 and that retailers are now mired in.
AT&T and Verizon won't likely go bankrupt or even have to restructure their debt in the near future, but their debt appears to be next up for some significant declines.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
To contact the editor responsible for this story:
Daniel Niemi at firstname.lastname@example.org