Is Distressed Debt A Harbinger Of A Declining US Economy?

Summary: At levels not seen since the financial crisis, is the distressed debt ratio sending a clear signal about the health of the US economy?

Will the Fed or won’t the Fed and, in fact, at the end of the day does it even matter when considering the health of lower rated companies?

High Yield Bonds: ‘A high paying bond with a lower credit rating than investment-grade corporate bonds, Treasury bonds and municipal bonds. Because of the higher risk of default, these bonds pay a higher yield than investment grade bonds.‘ (Source)

Distress Ratio: ‘The S&P’s distressed ratio is the number of distressed securities divided by the total number of speculative-grade issues. A speculative-grade issue, popularly known as “high yield” or “junk issue,” is an issue rated BB or lower because of the high default risk attached with the issuer. When these high risk securities go into or head towards a default, they’re called “distressed securities.” Distressed securities are securities that are already in default, under bankruptcy protection, or in distress and heading toward such a condition.’(Source)

In September 2015 the distress ratio reach 15.7% which at the time was the highest reading since 2011. At the end of November 2016…20.1%!

So what does that mean and is it a precursor for US economic angst down the road?

The website Wolf Street has provided an excellent article on the subject that is a very good read titled…

“Distress” in US Corporate Debt Spikes to 2009 Level

Investors bloodied as the Credit Bubble implodes at the bottom

Investors, lured into the $1.8-trillion US junk-bond minefield by the Fed’s siren call to be fleeced by Wall Street and Corporate America, are now getting bloodied as these bonds are plunging.

Standard & Poor’s “distress ratio” for bonds, which started rising a year ago, reached 20.1% by the end of November, up from 19.1% in October. It was its worst level since September 2009.

It engulfed 228 companies at the end of November, with $180 billion of distressed debt, up from 225 companies in October with $166 billion of distressed debt, S&P Capital IQ reported.

Bonds are “distressed” when prices have dropped so low that yields are 1,000 basis points (10 percentage points) above Treasury yields. The “distress ratio” is the number of non-defaulted distressed junk-bond issues divided by the total number of junk-bond issues. Once bonds take the next step and default, they’re pulled out of the “distress ratio” and added to the “default rate.”

During the Financial Crisis, the distress ratio fluctuated between 14.6% and, as the report put it, a “staggering” 70%. So this can still get a lot worse.

The distress ratio of leveraged loans, defined as the percentage of performing loans trading below 80 cents on the dollar, has jumped to 6.6% in November, up from 5.7% in October, the highest since the panic of the euro debt crisis in November 2011.

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

And the default rate, which lags the distress ratio by about eight to nine months – it was 1.4% in July, 2014 – has been rising relentlessly. It hit 2.5% in September, 2.7% in October, and 2.8% on November 30.

This chart shows the deterioration in the S&P distress ratio for junk bonds (black line) and leveraged loans (brown line). Note the spike during the euro debt-crisis panic in late 2011:

The oil-and-gas sector accounted for 37% of the total distressed debt and sported the second-highest sector distress ratio of 50.4%. That is, half of the oil-and-gas junk debt trades at distressed levels! The biggest names are Chesapeake Energy with $7.4 billion in distressed debt and Linn Energy LLC with nearly $6 billion.

Both show how credit ratings are slow to catch up with reality. S&P still rates Chesapeake B- and Linn B+. Only 24% of distressed issuers are in the rating category of CCC to C. The rest are B- or higher, waiting in line for the downgrade as the noose tightens on them.

Read the rest of the article at Wolf Street here.

Michael Haltman is President of Hallmark Abstract Service in New York. He can be reached at mhaltman@hallmarkabstractllc.com.