“We Are In Uncharted Junk Terrain”: Corporate Credit Quality Is Far Weaker Than In 2000 And 2007

Wednesday, October 10, 2018
By Paul Martin

by Tyler Durden
Wed, 10/10/2018

Last week, the euphoria over US high yield bonds hit new post-crisis highs when amid a sharp slowdown in supply, a rise in the oil price and generally solid economic conditions, insatiable buyers of junk sent the Bloomberg Barclays Corporate high yield spread to the lowest since before the financial crisis, dropping as low as 303bps, the tightest level since late 2007 before drifting somewhat wider during the late week bond rout.

As US junk bonds have remained surprisingly resilient in the face of last week’s rate rout, even as investment grade spreads have continued to drift wider resulting in a , questions have started to emerge about just how much longer this high yield complacency can sustain.

Addressing this issues, Michael Eisenband, co-head of corporate finance and restructuring at FTI Consulting, wrote that “we may be enjoying the longest bull market ever, but those skyrocketing security prices can’t hide the fact that it’s also “the junkiest bull market on record.”

One particular risk highlighted by the distressed debt expert is the ongoing deterioration in credit quality, as a result of which “we are in uncharted junk terrain today compared to precedent periods of the last three decades, with corporate credit quality, as measured by ratings distribution, far weaker than at previous credit cycle peaks of 2000 and 2007. It isn’t even close.”

Of note for junk bond bulls, Eisenband writes that “U.S. Corporate credit metrics, however you measure them, are worse today than they were in mid-2007 when the last credit cycle was peaking. Many speculative-grade companies, led largely by private equity sponsors and pliant lenders, are choosing financial exuberance and ignoring the lessons of the 2008 crash.”

Specifically, around 56% of all S&P-rated U.S. corporate issuers today are speculative- grade, compared with 49% in 2009. Putting the outstanding debt in context, there are currently 456 U.S. corporate issuers rated B- or worse, double the number in mid-2007.

As a reminder, over the weekend we reported that the next big risk for the corporate bond market is the $2.5 trillion in BBB-rated investment grade debt, which Morgan Stanley warned could see as much as $1.1 trillion in downgrades to junk, unleashing a shockwave across the bond market. As a reference, there is roughly $1 trillion in junk bonds, which means the next recession, and wave of downgrades, could double the size of the high yield market.

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