Ka-boom Goes the Bottom of the US Bond Market

by Wolf Richter

And it’s not just oil & gas!

The toxic pile of distressed corporate debt in the US grew to $285 billion in January, up 22% from a month ago and up 162% from a year ago, according to S&P Capital IQ. The number of distressed issuers ballooned to 324 US corporations, up 20% from a month ago and up 84% from a year ago.

The last time the total amounts of distressed debt and the number of distressed issuers had shot up to these levels was in October 2008, just after Lehman Brothers had filed for bankruptcy.

That’s how bad it is now in the US. It’s the essential consequence of years of artificially easy credit, the Fed-inspired blind confidence of yield-desperate investors, ludicrous corporate risk-taking to take advantage of those blind investors, private-equity asset stripping and buyouts, and among other things, the collapse of commodity prices that resulted from overproduction.

During the Financial Crisis, the total amount of distressed US corporate debt maxed out at $398 billion in December 2008 and then began to drop as the Fed was dousing the land with QE and started manually bailing out corporations and banks with emergency loans. Today, there are no bailouts in sight, and no one is talking about an emergency. So the distressed debt of $285 billion today is just the beginning.

These “distressed” credits are junk-rated bonds whose yields are at least 10 percentage points above US Treasury yields, according to S&P Capital IQ’sDistressed Debt Monitor. And this is what the trend in distressed debt looks like, in terms of dollar amounts (in billions, black line) and the number of distressed issuers (purple columns – purple to give them a lugubrious nuance):


And so Standard & Poor’s US Distress Ratio for bonds soared to 29.6% in January, up from 24.5% in December, and more than double its level a year ago (13.4%).

“The ratio indicates the level of risk the market has priced into the bonds,” explains S&P Capital IQ’s Distressed Debt Monitor. “A rising distress ratio reflects an increased need for capital and is typically a precursor to more defaults when accompanied by a severe and sustained market disruption.”

In September 2008, as the Lehman Moment was evolving, the Distress Ratio was still 28.9%, below today’s level. A month later, in October, it soared to 53.5% on its way to 70%. It took until August 2009, and lots of QE and bailouts, before the Distress Ratio fell below today’s level.

The chart below shows the Phoenix-like rise of the Distress Ratio of junk bonds (blue line) and the S&P/LSTA Leveraged Loan Index distress ratio (brown line), which lags a month, jumping from 7.8% in November to 9.1% in December:


The number of distressed issues jumped 20% from December to 524 in January. Oil & gas accounted for 156 distressed issues, or 30%. With $89.4 billion in distressed debt, it accounted for 31% of the total amount of distressed debt.

It’s convenient to blame oil & gas for the tremors in the junk bond market. But the remaining 70% of the distressed issuers are spread across other sectors – the “spillover effect to the broader speculative-grade spectrum.” It’s no longer just oil & gas!

In terms of dollars, the sector with the second most distressed debt is Telecommunications with $33.4 billion in distressed debt. Metals, Mining, and Steel is in third place ($28.7 billion), followed by Media and Entertainment ($26.6 billion).

The table shows the biggest debt-sinner sectors, in order of the amount of distressed debt. In parenthesis is the number of distressed issues:


So which are the companies in each sector with the most distressed debt?

Oil & Gas: Linn Energy with $6.9 billion in distressed debt; Chesapeake with $6.4 billion; Transocean with $5.0 billion, and California Resources with $5.0 billion.

Telecommunications: Sprint Corp with $10.5 billion, Sprint communications with $6.1 billion, and Sprint Capital with $4.2 billion for a combined total of a juicy $20.8 billion in distressed debt, worse than the top three energy debt-sinners combined! Then there’s Frontier Communications with $5.6 billion in distressed debt. And Windstream with $3.5 billion.

Metals, Mining, and Steel: Peabody Energy (coal mining) with $4.8 billion in distressed debt, Cliffs Natural Resources (iron ore) with $2.9 billion, and US Steel with $2.6 billion.

Media and Entertainment: iHeart Communications with $8.7 billion in distressed debt, Scientific Games International with $3.0 billion, Clear Channel with $2.2 billion.

So what can bondholders expect? Not much. The report:

About 72% of the distressed issues are either unsecured or subordinated. In a default, these noteholders’ claims to the firm’s assets are secondary to the more senior debtholders’.

Distressed issues are the weakest of the speculative-grade population. Therefore, their recovery prospects are low.

Of the distressed issues with available recovery ratings, 33% sport the lowest S&P recovery rating of “6.” In case of a bankruptcy, the expected recovery of principal and pre-petition interest is 0% to 10%. Another 16% of the distressed issues have a recovery rating of “5” with an expected recovery of 10% to 20%.

What we’re witnessing is not only the end of the credit cycle, but also the festering consequences of a majestic central-bank engineered credit bubble. Cheap and easy money paved the way. For highly-leveraged corporate borrowers, those were the best times ever. Investors were blind to risks. They’d buy anything. And Wall Street knew it. And so risks were no longer priced in. But that has changed. Some risks are starting to be priced in. And creditors are finding out that they’ve been taken to the cleaners.

And how are banks that lent to the oil & gas sector dealing with it? “All of it is in the gutter.” Read… Banks Much Deeper in the Hole on Oil & Gas Collateral than they Pretend


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