In the credit markets, we have seen an increasing trend in losses from corporate bonds and the potential for them to climb further means that investors are not being properly rewarded for taking additional risks, especially with junk bonds. According to Bank of America Corp, another added risk is the greater debt to asset ratio compared to previous cycles. The higher levels of borrowing means if a company liquidates, the proceeds have to cover more liabilities due to U.S. issuers having more debt relative to their assets.
By looking at the current number of U.S. dollar bond issuers that are trading at distressed levels, we can get another measure on the health of the U.S. corporate bonds market. This number has risen to the highest level since the 2008-2009 financial crisis with the credit-rating downgrades and tumbling commodity prices exacerbating the situation.
The current environment signals higher credits risks which directly affects banks' willingness to lend, specifically to industries that have been hit the hardest such as Energy.
The total volume of syndicated loans in the U.S. dropped from $2.02 trillion in 2014 to $1.89 trillion in 2015. The following tables show an industry breakdown of U.S. loans for 2014 and 2015. More specifically, you can see a drop in syndicated energy loans from $282 billion (13.95% of Market Volume) in 2014 to $214 billion (11.30% of Market Volume) in 2015.
- Figure 1: 2014 U.S. Loan Breakdown (Source: Bloomberg)
- Figure 2: 2015 U.S. Loan Breakdown (Source: Bloomberg)
Another market that has been showing signs of weakness has been the issuance of U.S. High Yield Corporate Bonds. First quarter of 2016 was the slowest start for U.S. junk issuance since the 2008-2009 financial crisis. Issuance is down approximately 57% from a year earlier, at $41.5 billion in the first quarter of 2016 versus $96.9 billion for the first quarter of 2015.
Big banks have also been feeling the pain from the oil crash. JPMorgan Chase & Co., Wells Fargo & Co., Bank of America Corp and Citigroup Inc., all announced that they are setting aside more money to cover potential losses. This has contributed to a tighter lending environment in the energy sector moving forward.
Several hedge funds and private equity firms have already been positioning themselves for the upcoming stage in the credit market. KKR, Oaktree Capital Group LLC, Bain Capital's Sankaty Advisors, and Fortress Investment Group LLC are among many who are raising capital for distressed investments as they are bracing for acceleration in defaults and a shift in the credit cycle.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.