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The reckoning day for a massive default crisis has finally arrived. The loosen Federal Reserve policies have turned out to be the trigger to a major debt bubble that will crush a dramatic number of businesses for good while disrupting all the prospects for a swift economic recovery.
We’re in the middle of a new era of U.S. businesses bankruptcies, and 99% of the losses experienced so far are related to bond defaults. In this video, we analyze the current economic landscape that points to a major corporate debt bubble burst has just started.
Economists have been alerting that a default cycle was forming and it would be marked by record low recovery rates. The first signal for it was the disconnect between fundamentals and asset prices, resultant from the Fed’s constant manipulation of markets, then the huge amount of debt upon debt, most of it secured. And finally, the years of covenant-lite deals which obliterated creditor protections.
Now, a recent publishing described that bondholders are battling over recoveries as low as 1 cent. After seeing an economy hardly hit by the health crisis, which prompted widespread shutdowns that sparked a major spike in bankruptcy filings, many lenders are starting to realize their claims have become entirely pointless. Which means, many unsecured creditors now face the unenviable prospect of walking away with just pennies.
This epic collapse in recoveries can be seen in the current price of retailers’ bonds, some of which have the lowest-priced debt, worth just 0.125 cents on the dollar. This year, the median value for companies’ cheapest debt in credit derivatives auctions is merely 3.5 cents on the dollar, an all-time low which is far below the past 23.4 cent median. Such derisive figures corroborate with the assertion that record-low recoveries for bondholders are now the norm.
Desperate to generate larger returns in a decade of rock-bottom interest rates, money managers bargained away legal protections, embraced ever-widening loopholes, and decided to turn a blind eye to questionable earnings projections. While corporations took advantage and overindulged on astronomical amounts of debt that many now cannot repay or refinance.
Of course, the Fed’s extraordinary monetary policies are one of the main reasons for this substantial surge in corporate debt, but now, amid a new bout of economic pain, the effects of those policies are coming to bear.
A study by LCD examined the debt cushion of outstanding loans discovered that today’s covenant-lite deals have almost no debt cushion beneath them, which significantly reduces what an investor can recover on a loan if that credit defaults.
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The health crisis has acted as a catalyst to trigger this unprecedented wave of defaults, and lockdowns pushed the situation to another level of complexity, severely disrupting industries such as retail and energy, but despite the effects of the outbreak, the core issue for most companies was the explicit endorsement of the Fed to accumulate overwhelming levels of debt over the past decade, then topping up with more debt to get through the current economic collapse.
Valuations have fallen so deep and asset values are so depressed, even secured debt is dealing with drastic impairments. At this stage, loan investors could find themselves losing 40 to 45 cents on the dollar, compared with historical averages of 30 to 35 cents. As a result, it seems that creditor pain is only starting, and considering almost 20% of the debt in the U.S. high-yield bond market is now in some way secured, another tsunami of bankruptcies that will likely resonate on the burst of the corporate debt bubble once again – and this time, there’s nothing the Fed can do to stop the bleeding.”