International Forecaster Weekly

Distressed Debt Jumps 300% in 2022

Sorry for the cliché, but the more things change, the more they remain the same. 

Nowhere is this more painfully obvious than in the financial industry – where cracks are expanding in already porous credit dykes all over the world.

You think we'd have learned from the disastrous effects of the Great Recession 15 years ago.

But after additional years of excess from banks stuck with piles of buyout debt, a pension blow-up in the UK and real-estate troubles in China, South Korea and more recently the U.S., we’re finding again that what’s past is prologue.

Thanks to global central bank rate hiking, cheap money is quickly becoming a thing of the past. 

Distressed debt in the U.S. alone jumped more than 300% in 12 months, according to Bloomberg News.

Plus, high-yield issuance is much more challenging in places like Europe, and leverage ratios have reached record levels.

The aggressive rate hikes have dramatically changed the landscape for lending – stressing credit markets and pushing economies toward recessions, a scenario that markets have yet to price in.

Nearly $650 billion of bonds and loans are distressed, according to Bloomberg. 

It’s all adding up to the biggest test of the stress tolerance of corporate credit since the 2008 financial crisis and may be the spark for a wave of coming defaults.

Will Nicoll, chief investment officer at M&G, said, “It is very difficult to see how the default cycle will not run its course, given the level of interest rates.”

Banks say their wider credit models are proving robust so far, but they’ve begun setting aside more money for missed payments.

Loan-loss provisions at systematically important banks surged 75% in the 3rd quarter compared to 2021 – a clear indication they’re preparing for payment issues and defaults.

Most economists see at least a moderate GDP slump over the coming year. 

Some, like Paul Singer of Elliott Management, however, fear a deep recession could cause significant credit issues because the global financial system is “vastly over-leveraged.” 

Citigroup economists believe rolling recessions are likely across the globe next year, with the U.S. likely to slip into one by the middle of next year.

Mike Scott at Man GLG warned that “markets seem to be expecting a soft landing in the U.S. that may not happen.”

Guest Writer | January 4, 2023

By Dave Allen for Discount Gold & Silver

Sorry for the cliché, but the more things change, the more they remain the same. 

Nowhere is this more painfully obvious than in the financial industry – where cracks are expanding in already porous credit dykes all over the world.

You think we'd have learned from the disastrous effects of the Great Recession 15 years ago.

But after additional years of excess from banks stuck with piles of buyout debt, a pension blow-up in the UK and real-estate troubles in China, South Korea and more recently the U.S., we’re finding again that what’s past is prologue.

Thanks to global central bank rate hiking, cheap money is quickly becoming a thing of the past. 

Distressed debt in the U.S. alone jumped more than 300% in 12 months, according to Bloomberg News.

Plus, high-yield issuance is much more challenging in places like Europe, and leverage ratios have reached record levels.

The aggressive rate hikes have dramatically changed the landscape for lending – stressing credit markets and pushing economies toward recessions, a scenario that markets have yet to price in.

Nearly $650 billion of bonds and loans are distressed, according to Bloomberg. 

It’s all adding up to the biggest test of the stress tolerance of corporate credit since the 2008 financial crisis and may be the spark for a wave of coming defaults.

Will Nicoll, chief investment officer at M&G, said, “It is very difficult to see how the default cycle will not run its course, given the level of interest rates.”

Banks say their wider credit models are proving robust so far, but they’ve begun setting aside more money for missed payments.

Loan-loss provisions at systematically important banks surged 75% in the 3rd quarter compared to 2021 – a clear indication they’re preparing for payment issues and defaults.

Most economists see at least a moderate GDP slump over the coming year. 

Some, like Paul Singer of Elliott Management, however, fear a deep recession could cause significant credit issues because the global financial system is “vastly over-leveraged.” 

Citigroup economists believe rolling recessions are likely across the globe next year, with the U.S. likely to slip into one by the middle of next year.

Mike Scott at Man GLG warned that “markets seem to be expecting a soft landing in the U.S. that may not happen.”

The leveraged loan market has skyrocketed recently. Last year, $834 billion of leveraged loans were issued in the U.S., more than double the rate in 2007 before the Great Recession hit.

As demand has grown, so has the risk. In new U.S. loan deals this year, total leverage levels are at a record versus earnings. 

There’s also an earnings recession on the horizon, Morgan Stanley strategist Michael Wilson has warned, which will make matters worse.

Leveraged loans have seen the “greatest buildup of excesses or lower-quality credit,” according to UBS strategist Matt Mish. 

He said that default rates could rise to 9% next year if the Fed stays on its aggressive tightening path in 2023 and possibly 2024. “It hasn’t been that high since the financial crisis.”

Many investors may have been caught off-guard by the Fed this year. 

They’ve consistently bet that the threat of recession would cause the Fed to apply the brakes, only to have been burned again and again by a series of 75 basis point rate hikes.

While the pace of those increases has begun to slow, Fed chair Jerome Powell has been clear that rates still have to go higher than originally expected and will stay elevated for a longer period of time.

Still, many WallStreeters have refused to treat these moves as a sign of a coming recession.

What’s more, all this rising debt is growing more expensive to service.

The Secured Overnight Financing Rate (SOFR) – a dollar benchmark for pricing that’s replaced LIBOR – is about 430 basis points, an 8,500% increase since the start of the year.

There’s another reason causing concern. More than 90% of the leveraged loans issued in 2020 and early 2021 have limited restrictions on what borrowers can do with the money.

With markets overflowing with cash, more companies have opted for cheap loans with fewer covenants, a phenomenon that’s altered balance sheets.

Historically, corporates typically used a combination of senior loans, bonds that ranked lower in the payment scale and equities, to fund themselves. 

Over the last decade, however, demand has allowed firms to cut out the subordinated debt, meaning investors are likely to get less money back if – and when – borrowers default.

December is poised to position gold and silver for a potential banner 2023. 

From its start to the month at $1,756, gold is up $72 or 4.0% at $1,828 as of mid-afternoon today – the last trading day of the year. 

That would end 2022 just as it started – a strong ending to a year that saw a broad range of prices, from a high of $2,070 in early March to a low of $1,639 in late September, as gold followed the ups and downs of the dollar.

Silver’s had an even more solid December, starting the month at $21.85 and on the verge of ending it above $24.00 – a big gain of 10.0%. 

For all of 2022, silver is up $1.10 or 4.8% from its start of $22.95 – with a closing high of $26.62 in early March and a low of $18.11 on September 1st.