Leaving ugly skid marks on the economy, banks, and investors.
The “end of the credit cycle” is a harmless-sounding moniker for an era when defaults and bankruptcies suddenly re-materialize, as if out of nowhere, and when investors get to eat big losses in what they thought were conservative investments.
It’s when new money for Corporate America gets a little more skittish, and credit just a little tighter – not all at once, but over time. And for over-indebted junk-rated companies, that slight tightening and the accompanying rise in rates at the top triggers liquidity crises, defaults, and bankruptcies at the bottom.
Ratings agencies have responded to the end of the credit cycle by downgrading companies in a relentless tango. With each downgrade, credit tightens just a bit more for these companies, causing additional risks and operational difficulties. As liquidity dries up for them, they slash investments and cut costs, which wipes out the hope for growth – the essential ingredient that kept the illusion alive.
In that vein, Standard & Poor’s reported that it downgraded 44 US junk-rated companies in March, while upgrading just 15. This comes on top of the 82 issuers it downgraded in February. In the first quarter, about 45% of S&P’s downgrades hit oil & gas companies. Not a surprise, given the state the industry is in. But 55% of the downgrades hit companies outside oil & gas!
Note that top among the reasons S&P cited for the March downgrades is “operating performance.” That includes the disappearing hope for growth:
- Operating performance, deteriorating or expected to deteriorate (17);
- Potential lack of liquidity or rising potential for default (15);
- Merger, acquisition, or asset sales (2).
So S&P sees a “Spike in Defaults” as the “hangover from years of lenient credit may become painful.”
But this gloomy outlook concerns only part of the business world: larger companies with debt securities that are rated by the ratings agencies.
That part of the world, after years of profligate borrowing from over-eager investors that the Fed had blinded with its monetary policies, is in trouble, though now Wall Street soothsayers are once again running around and beating the bushes, proclaiming that junk bonds are a great deal. And they have to, because without new money, the entire house of cards comes tumbling down.
But for the rest of the over-indebted American business world, the outlook may be even gloomier. These are the smaller companies that are not showing up in these statistics because they’re too small to issue bonds and aren’t rated by Moody’s, Fitch, and S&P. They’re struggling in a very tough environment marked by slack demand.
And bankruptcies have soared.
Total commercial bankruptcy filings by corporations of all sizes and other business entities in the first quarter jumped 24% from a year ago, to 9,208, according to American Bankruptcy Institute. Of that total, commercial chapter 11 filings rose 9% to 1,419. In March, it was even worse: total commercial bankruptcy filings jumped 25% year-over-year to 3,351.
“Distress in the energy and retail sectors is represented in the increasing total of business filings, and we are also seeing a rise in individual chapter 11 filings,” explained ABI Executive Director Samuel Gerdano.
This follows 22 quarters in a row of year-over-year declines in bankruptcies. Something is suddenly broken. Hope has gone out for these businesses; now they have to “turn to the financial relief of bankruptcy,” as Gerdano put it.
And this is just the beginning. The Fed’s easy-money policies made every credit sin possible by encouraging yield-starved investors and banks to take ever greater risks. But now the credit cycle has turned, not just for the large corporations with too much debt on their balance sheets that the ratings agencies report on, and that they reluctantly downgrade when it becomes inevitable, but particularly for the innumerable small and much more vulnerable businesses that are struggling with lousy demand.
In aggregate, these smaller companies are crucial to the US economy. They’re traditionally where much of the employment growth comes from. So this turn of events, as it is now starting to play out from here on forward, is going to leave some ugly skid marks on the economy, banks, and investors alike.
“A hostile landscape” – that’s what BlackRock CEO Larry Fink called the global situation, where investors “are facing tremendous uncertainty, fueled by slowing economic growth, technological disruption, and social and geopolitical instability. And there’s a culprit. Read… Negative & Low Interest Rates Eat into Consumer Spending at Worst Possible Time: BlackRock CEO Fink
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.