If you’re casting a wary eye towards corporate credit right now, you’ll be forgiven.
After all, the world just plunged into the closest thing to a global depression witnessed in more than a century and, stateside, there’s incessant chatter about the likelihood that today’s liquidity crunch will be tomorrow’s insolvency crisis.
A tsunami of bankruptcies is now a foregone conclusion. Indeed, casualties are piling up almost by the day, from shale drillers to telecoms to retailers.
While many of the firms which have succumbed over the past several weeks likely “had it coming” (so to speak), there’s palpable concern in the market that the debt companies are taking on to weather the COVID storm will be impossible to service down the road.
In other words, in addition to accelerating the end game for companies that were already beset by balance sheet mismanagement and unfavorable market trends, the necessity of borrowing to stay in business during the crisis may sow the seeds for credit events later, if that new debt proves to be unsustainable.
Commenting for a Bloomberg piece dated May 7, Derek Pitts, head of debt advisory and restructuring at PJ Solomon, delivered a truly dour assessment:
Everyone’s distressed watch list has become so big that it doesn’t even make sense to call it a watch list — it’s everyone. You turn page after page and it’s all red. It’s a sea of red.
Damn, Derek. Don’t sugarcoat it or anything.
Pier 1 Imports said Tuesday it will close forever, and although I’m not sure anyone is going to miss tip-toeing around cramped floorspaces to pick through absurdly overpriced wicker giraffes and sundry decorative plates, it’s a somewhat depressing sign of the times.
“This decision follows months of working to identify a buyer who would continue to operate our business going forward”, Pier 1 CEO Robert Riesbeck lamented, in a statement. “Unfortunately, the challenging retail environment has been significantly compounded by the profound impact of COVID-19, hindering our ability to secure such a buyer”.
This is hardly just a developed market problem. Moody’s EM Liquidity Stress Indicator (a gauge which shows the percentage of high-yield emerging market companies with the weakest liquidity profiles) hit 23% in April. That’s a record, and well above the long-term average.
“After a low default rate in 2019, coronavirus-related disruption and market uncertainty will likely push defaults much higher”, a presentation out Wednesday reads. “We expect the trailing 12-month speculative-grade default rate for EM companies will rise to between 7.8% and 11.2% by year-end 2020 from 2.2% in March 2020”. That’s quite the jump.
And yet, through it all, investors may have little choice but to invest in corporate credit despite the looming tsunami of bankruptcies, defaults and restructurings.
Why? Well, because the alternatives aren’t great.
Consider, for example, the ratio of global corporate bond spreads to yields on government bonds. The visual in the left pane shows that ratio perched at the highest ever, easily blowing past levels seen following Lehman. “This effectively implies how difficult it would be for fixed income investors to avoid corporate bonds over the medium to longer term, even if they do not find a lot of value in credit spreads on an absolute basis”, JPMorgan’s Nikolaos Panigirtzoglou writes.
Although the visual on the right isn’t as extreme, the spike still shows that, at least on one simple measure, there’s relative value in credit. “It shows how difficult it would be for multi-asset investors to avoid corporate bonds… given how elevated credit spreads are currently compared to equity yields”, Panigirtzoglou says.
Of course, the other thing you’ve got going for you in credit is that, as long as you’re buying IG or recently fallen angels, you’re investing alongside central banks – including the Fed.
So, when you look up a year from now and you’ve got a portfolio full of heavily discounted wicker giraffes and decorative plates, at least you’ll be in “good” company.