The High Yield Problem

This goes back to the negative feedback loop I discussed last week, the auto-catalyst that Wall Street jerks off to whenever there is a crisis.

The reason why the financial crisis happened was because we went from super low rates and the subprime mortgage industry was built upon it — homeless men in mansions borrowing from their HELOCs. Today, after a decade of ZERO interest rates, what do we have? Corporate balance sheets FESTOONED with debt, taken out to buoy stock prices, pay bonuses, having a grand old time.

But what happens when the party ends and companies like At&t stare into the abyss and see $186 billion in debt?

The debt/equity ratio comes into play and when the equity part of the equations drops off, the debt becomes all the more meaningful. As unbelievable as it might seem, if the debt/eq ratio gets too out of whack, confidence is lost and the underlying company is considered insolvent. Covenants are broken and the stock goes to zero.

How much debt are we talking about? Excluding the banks, who have trillions by themselves, we’re looking at around $10 trillion plus. Look at the graphic below, provided by Exodus, and you can see the average debt/eq ratio is under 0.8. Some sectors are worse than others. For example, the oil and gas industry has about $300b barreling into the danger zone.

This distress can be seen in HYG or JNK, as bonds for lower quality debt reflect the deterioration in the fundamentals.

And here’s ~$2 trillion in debt whose stocks have raced down more than 10% today. The average debt/eq ratio for these bowsers is 2.3x.