Dim Outlook for Corporate Debt: No Market for Junk Bonds?

Jun.16.10 | About: SPDR Barclays (JNK)

Monday morning, the S&P released a report stating that American companies may find themselves unable to handle tremendous debt. The report states that over the next four years, debt will gradually increase, particularly the speculative category. Is this a cause for concern?

According to the report, by 2014, the amount of debt due will rise to $550 billion, 72% of which is speculative. Next year, there will be $300 billion debt, approximately 40% of which will be speculative. In fact, domestic companies have about $1.8 trillion in S&P bonds and loans maturing within the next 4 years.

These numbers are of huge concern and should not be overlooked. Junk bonds have not been the most appealing investments in this time of uncertainty, given the economic climate in Europe and recession in the United States.

I would be very concerned about companies at the low end of the ratings scale. John Bilardello, a managing director at Standard & Poor’s, said in the report:

We believe that many borrowers at the low end of the ratings scale will encounter serious hurdles to their refinancing needs in 2013 and 2014. Unlike investment-grade entities, for which the main issue is the rising cost of capital, speculative-grade borrowers may find that financial institutions and investors are wary of lending to them.

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Investors may continue to stay away from speculative debt given the sovereign debt crisis in Europe. With phases of flight-to-quality, there still be may be some time before we see more confidence in low rated debt.

Where did all this debt come from anyways? Were companies too optimistic during booming eras, and/or were lenders too generous? During bullish times, we often get too optimistic, failing to realize the implications of being too generous or the eventual emergence of a bubble burster. Back in the economic boom which ended in late 2007/early 2008, there was a tremendous rise in leveraged buyouts as private equity firms were borrowing immense capital, resulting in a huge debt burden for target companies. As the economy hit an infection point and steered downwards, profits were minimal and companies were unable to unload their debt.

Over the last year or so, many companies have been refinancing their debt. The rating agency believes that the next few years will be a difficult time for companies to refinance, leading to a surge of defaults. We may not necessarily enter into an era of bankruptcies, but we may see corporate downgrades. With low demand for junk bonds, and huge debt levels, we should not get too optimistic yet that the recession is behind us.

Disclosure: No positions