Are we headed for a credit crisis? Our US capital markets reporter answers your questions


As people retreat to their homes and businesses shutter, the impact of coronavirus risks plunging the global economy into the worst crisis in more than a decade. Our US capital markets reporter Joe Rennison has been living and breathing this story, and is here to answer your questions.

Focused specifically on US credit, Joe has covered news lines from the dramatic rise in corporate borrowing costs, big companies’ dash for cash and the Fed’s decision to help debt market conditions.

On Friday Joe took to the social platform Reddit and invited users to participate in its infamous “Ask me Anything” question-and-answer session (AMA for short) — he discussed topics with users that ranged from bonds to banks to exchange traded funds.

Here are the highlights. If you have a follow-up question, leave it in the comments on this article. Joe will be dropping in to respond a few times over the course of the day.

Reddit user __plankton__: What are your thoughts on the Fed stepping in to buy corporate debt? There is no precedent for how this will pan out, but surely this will help given they are including the junk grade bonds you’re worried about.

Joe Rennison: So, they’re NOT including junk bonds. Just investment grade bonds. The idea is that if banks don’t have capacity to intermediate in markets and alleviate selling pressures, then the Federal Reserve needs to do it to support corporate credit and ensure companies have access to the debt market to raise desperately needed cash. This could trickle through to high yield over time. If the Fed buys up a large chunk of investment grade bonds, then there are fewer out there for investors to buy. Instead, investors are pushed to seek out other assets, like high yield. This is what we saw happen after 2008 when the Fed first started ramping up Treasury purchases. It dragged down yields in the government bond market, pushing investors to seek out returns in corporate bond and stock markets. 

Reddit user __plankton__: Gotcha, thanks for the clarification. Should we really be all that concerned about junk-rated bonds defaulting at a higher rate? How much of the debt markets do these companies represent? How systematically important are they?

Maybe I have too much faith, but if investors are buying junk bonds, shouldn’t they know what they’re signing up for? I feel like the 18 per cent default rate you cited earlier is more of a symptom than an underlying issue, and any bondholder likely has their portfolio at least somewhat balanced with investment grade debt.

JR: In the 2008 financial crisis default rates hit about 13 per cent for high-yield, according to Moody’s. The high-yield bond market is about $1.2tn, compared to roughly $7tn of investment grade bonds. The typical high-yield bond mutual fund has at least 80 per cent of its assets invested in the market.

If you’re wondering if there are folks out there unhedged, I suggest looking up Robert Smith’s excellent reporting on H20’s woes. Part of the issue is that after a decade of low interest rates, investors are pushed to finance more and more risk in an attempt to generate returns, creating more and more debt-laden companies. Investors now have the option to sell out of these positions and take the hit, hope for a rebound or stick with companies through bankruptcy and hope a restructuring ends up paying them back over time. But there is certainly space for losses, and as companies default that can create knock-on effects to other companies as well. 

Reddit user Jessrogo42: Do [corporate] defaults pose systemic risks? If so, what is the mechanism? I suppose if corporate bonds are being used as collateral, their fall in value could trigger repurchase agreement default provisions? Also, what’s the deal with corporate bond ETFs? Are they malfunctioning due to a lack of liquidity?

JR: On systemic risk. The shutdown is likely to create a big revenue shock for companies. That in turn tightens credit conditions — companies’ ability to get their hands on cash. If company’s begin to renege on their debts and fall into bankruptcy that has a knock-on effect. One company’s slashed costs is another company’s lost revenue. And so on. This is how the risk could spread from companies that were already risky coming into this crisis to other companies that right now might look OK. 

On corporate bond ETFs. Here’s an explainer I wrote this week on this issue.

In short, hard to say, but most of the people I speak to say the dislocations seen in ETFs are more [of] a problem with the underlying bond market. Bonds don’t trade as often as ETFs, so ETF proponents say the product is showing the real-time true price of credit, whereas bond prices are becoming stale. 

Reddit user Filips_de_Stoute: Obviously if the economy effectively has to be shuttered for the better part of a year-plus (as the Imperial study predicted) we’re probably screwed anyway, but if the lockdown is of a more reasonable length, are financial institutions in better shape to avoid a credit crunch compared to 2008?

JR: Financial institutions are likely [to be] fine whatever happens here. At least compared to other areas people are worried about. Banks are in significantly better shape than entering the last financial crisis. Capital rules have been strengthened and the concern is not focused on them this time around. Elsewhere, the picture is more murky. Companies are more indebted now than they have ever been. A decade of low borrowing costs have resulted in a big increase in the amount of corporate debt outstanding. If that debt starts to become a burden on companies, then it could quickly ricochet through the economy.

The sort of good news; we are entering into this crisis with debt maturities extended and interest coverage — the cash companies have to pay their debts — high. But that can change rapidly. Already lower-rated companies have been cut off from debt markets. If that continues, servicing these big debt piles becomes harder and harder. 

Reddit user Frequent__nomad: Corporate debt has been an area of concern for a while. With SoftBank, and more importantly Ford, having their debts downgraded, is this the start of realising the risk that has been written about?

JR: Good question. There has been a fear among regulators and investors that an economic downturn will result in a swath of downgrades, sending debt tumbling from “investment-grade” into “high-yield”. This is problematic because the investment grade universe is just much bigger than high-yield, so with fewer investors to buy debt after a company has been downgraded, borrowing costs tend to rise, and could accelerate a downturn.

Taking Ford specifically, as I wrote about that downgrade recently, this was the one everyone was waiting for. Ford’s bond yields had already risen significantly on expectations it would be downgraded. But there aren’t many other companies on the precipice of being downgraded with the same amount of debt as Ford. Instead, what’s more likely is a raft of smaller companies being downgraded. Bank of America estimates that, including Ford, there will be about $200bn downgraded from investment grade into high yield. That’s a lot, but may not be unmanageable. Nonetheless, it doesn’t mean there aren’t risks facing corporate credit right now. There are. As I have noted in other replies. 

Reddit user Theg33k: The financial institutions are insolvent, that’s why the Fed has announced unlimited QE and is going to be purchasing assets. The financial institutions won’t be allowed to fail. They will get bad assets off their books (on to the Fed’s books, Fed will overpay) and will be given zero per cent interest loans that they can turn around and lend to consumers and businesses. So the financial institutions are insolvent, but they are being given free money like crazy.

JR: This actually raises an interesting point. To my last comment, banks are themselves broadly fine. They are well-capitalised. But what this has done is reduced the amount of capacity they have for intermediating in markets and taking risk.

A lot of this trading activity has moved out of banks. What we have seen as markets have sold off is a number of investors rushing for the exits and trying to unwind trades. Normally banks intermediate, matching buyers and sellers, but when there is just a mass of selling activity, that becomes harder . . . and without balance sheet capacity, banks are unable to simply hold those assets on their own books. Investors say this has contributed to the wild swings we have been seeing in markets. It’s also why the Fed has had to come in and buy assets — from Treasuries to mortgages and corporate bonds (which it didn’t even do in the crisis).

The point is, this is a very different crisis to the last one. The last crisis in 2008 was focused on the liquidity of banks. This is more centred on the liquidity of investors and the companies they finance. In turn, the Fed (and government) has responded by seeking out new ways to try and get cash into the hands of those that need it. 

Reddit user ekmokaya: So what companies do you think are best-positioned in the event of a recession like we are expecting?

JR: It might be easier to answer that with which companies are struggling the most. Energy companies in the US have been hit hard by the double whammy of coronavirus and falling oil prices. Next, anything related to travel and tourism and leisure activities (think hotels, cinemas, airlines, etc). On the other end of the spectrum, so-called defensive companies such as utilities have fared better than most. The technology sector still leads the S&P as well. Amazon is positive for the year, and Netflix’s stock price is also still positive for the year — I wonder why! In debt markets, bond sales have reopened in the past couple of weeks, boosted by Fed support. It’s big, blue-chip companies that have come to market, like Berkshire Hathaway, Coca-Cola, Pfizer, Exxon. This week we have seen that spread to lower-rated investment grade companies rated triple B, which is one notch above being considered “junk”. But still, no new high-yield bonds since the beginning of this month. 


Have a question? Leave it in the comments below, and Joe will be responding a few times over the course of today. You can also follow Joe on MyFT or on Twitter at @JARennison.

Compiled by Kai McNamee


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