Credit quality is deteriorating, and if stocks head south, many companies with weak financials would be shut out of both equity and debt financing. From Wolf Richter at wolfstreet.com:
“Weakest link” companies worst since October 2009.
The “weakest links,” according to S&P Global Ratings, are financially squeezed companies that S&P rates B- (neck-deep into junk), with “negative” rating outlooks or negative implications on CreditWatch. They’re uncanny predictors of corporate defaults. When the number of “weakest links” rises, the default rate will soon rise as well. The last three times it rose enough, a recession kicked in. The last two times were accompanied by fabulous fireworks in the markets.
In August, the number of “weakest link” companies rose to 251, the highest since October 2009, up from 140 two years ago, and heading toward the record of 300 in April 2009 when the financial world was coming unglued.
These weakest links have $359 billion in debt outstanding.
They serve as “potential default indicators” because they’re almost 10 times more likely to default than run-of-the-mill junk-rated companies, according the S&P report, cited by Bloomberg. Blame oil and gas? The markets surely would like to. But only 62, or 25% of the weakest links, are oil and gas companies. The next largest sector: 34 financial institutions for a share of 14%.
Among the eight companies that were inducted to the elect group in August: Chesapeake Energy, Hornbeck Offshore Services, satellite operator Intelsat which is already holding a gun to bondholders’ heads to get them to undergo a bond exchange with haircut, which S&P called “a distressed restructuring and tantamount to default.”
And it includes Tesla, which is burning cash faster than anyone can keep up with, and which has been raising even more cash via a torrent of follow-on stock offerings and debt sales, all to maintain enough liquidity. More on that in a moment.
The S&P US default rate rose to 4.8% as of July. S&P expects it to rise to 5.6% in June 2017. That may be optimistic. The default rate was 1.4% in July 2014. As it began rising over the past two years, S&P consistently underestimated how far it would go. Last November it was 2.8%. In nine months, it has jumped 2 full percentage points.
The default rate for energy companies is 21.7%.
And yet, liquidity is once again sloshing knee-deep through the system, trying to find a place to go. This includes refugees from negative interest rates in Europe and Japan. In this environment, even teetering Chesapeake was able to swap debt for equity and raise new money to be burned in the near future.
It’s hard to default when you keep getting new money to service old debts. Junk-rated issuers, now a hot property for NIRP refugees, have been able to refinance their debts and raise money to cover operating losses.
In that vein, back to “weakest link” Tesla. S&P rates it B-. The next step down is CCC. On August 1, S&P warned that it might downgrade it further, following its $2.6 billion acquisition of another money-losing, cash-burning Elon Musk company, over-indebted SolarCity. S&P slapped a CreditWatch “negative” on Tesla, based on “significant risks related to the sustainability of the company’s capital structure following the proposed transaction.”
Together, Tesla and SolarCity had over $5 billion in long-term debt at the end of March, and the deal would cause a “meaningful increase in the combined entity’s debt leverage.”
To continue reading: How a Small-ish Stock Market Swoon Might Unleash the Next Credit Nightmare
