If a company has too much debt and too little income, it’s going to struggle to pay its bills, regardless of when its bonds come due.
It’s a painful wakeup call for investors who’ve gotten used to high-yield debt being synonymous with big returns in an era of unprecedented Federal Reserve stimulus. Even as companies have pushed back debt maturities and lowered interest expenses, that doesn’t mean they can continue to work magic in the face of a slowing world economy and oil prices that have fallen 51 percent since the 2014 peak.
Indeed, the speculative-grade default rate has already begun ticking up from historically low levels, even though most existing corporate bonds don’t have to be repaid for another four years or more. Take American Eagle Energy Company, which filed for bankruptcy after missing the first coupon on a bond it issued just seven months earlier.
The corporation is “a recent winner of the credit market’s version of the NCAA (as in ‘No Coupon At All’),” Lovitt wrote.
Standard & Poor’s calculates the energy and natural resources default rate at 6.9 percent for the past 12 months from 4 percent six months earlier, and UBS AG analysts expect the rate to accelerate.
“How high will energy default rates go?” UBS analysts Matthew Mish and Stephen Caprio wrote in a July 9 report. “We have been very consistent on this question: 10 to 15 percent by mid-2016.”
The pool of distressed U.S. corporate bonds, typically those yielding more than 10 percentage points above benchmarks, has swelled to $127 billion, from the low last year of $43.7 billion, Bank of America Merrill Lynch index data show. This month alone, Peabody Energy’s $4.8 billion of bonds have fallen 14.9 percent, while Cliffs Natural Resources’s $2.5 billion of notes have declined 14.6 percent.
The most-indebted companies are generally more vulnerable to hiccups, such as oil prices that have fallen to about $52 a barrel from as high as $61.82 last month.
The International Monetary Fund this month downgraded its forecast for global growth, and China’s facing a roller coaster in its stock market, as economists forecast its slowest annual expansion since 1990.
There’s a reason the highest-yielding U.S. bonds are called distressed.