In February and March, the situation seemed pretty serious with some large banks buckling under the pressure of the aggressive interest rate rises initiated by the Federal Reserve. Silicon Valley Bank, Signature Bank and First Republic Bank were all reorganized by the Fed and since then many have been waiting on pins and needles for the tsunami of banks to follow suit. That hasn’t happened yet. That is at least in part because the Fed has created another mechanism for banks that have assets that aren’t worth what they paid for them to kick the can down the road. Lending funds have been put in place so that banks can borrow money from the Fed to cover up the capital losses that are on the banks’ books when they need liquidity. Whether that is a good long-term strategy or not, for the short term, the giant wave of bank failures has been averted. Cracks are showing in the dam as now one of the bank rating agencies has downgraded 10 small to regional banks. This is not a precursor to a tsunami – but it should be kept on the radar!
But what about the corporations outside the banking world that aren’t directly under the watchful eye of the Fed? They aren’t getting an immediate helping hand from the Fed and cracks in this dam are starting to show as well. For years we have described our concerns about the corporate bond world. Going into the Covid disaster we were struggling with corporate debt. Very concerning was the buildup of the lowest investment grade of debt – basically bonds that with just a tiny downgrade would get labeled “junk” bonds. Then the selling would start… We also had “zombie companies” which were organizations that had to continue to borrow more money just to pay the interest on the money that was already borrowed. These issues had come about with interest rates at the lowest in our history. Wouldn’t you expect drastically higher interest rates to exacerbate these already tough situations?
It looks like that is starting to happen. So far (through the end of July) in 2023 more than 400 publicly traded corporations have filed for bankruptcy protection. This is double the rate seen last year at this time and of course fears are that the true negative effects of higher interest rates haven’t completely filtered into the economy yet. Sixteen of these 400 companies have more than $1 billion in liabilities the most notable of course being Silicon Valley Bank and Bed Bath and Beyond.
Historically one of the biggest indicators that market participants watched as an indicator of bond-market problems was the spread between junk bonds and treasuries (high risk vs no risk.) Below is an historical perspective on the difference between those two interest rates…
When you see the panic of 2008, it makes today look like a walk in the park. Meaning – when there was true market panic like there was in the 2008 meltdown, high risk companies had bonds paying almost 20% more than no-risk treasuries to compensate for the risk. Today that spread is 3.83% and well within historical norms. That doesn’t spell disaster. We will discuss in later posts some of the changes that regulators have made to help high-yield bonds. That is ANOTHER kicking of the can down the road, but for today let’s just agree that Armageddon is not coming imminently… Lots of corporate debt will have to be refinanced in the next year – which could DEFINITELY change this chart if they have trouble with the higher rates, so we have to keep this indicator on our radar!
We have talked about corporate bonds, the overwhelming majority of which are at fixed rates. But what about the several trillion in bank loans to corporations – the majority of which are on variable rates. Let’s take a look at a chart of delinquency on those – because that is where the higher interest rates may really be felt by our capital system…
This chart looks quite benign also and this is the real surprising part. Remember, corporations took on a load of debt -bonds and loans – during the pandemic. The bonds were longer term with low and fixed interest rates. Clearly that isn’t the most dangerous part of our debt bubble. But wouldn’t we expect variable rate (now going higher in interest rate) loans to be the non-performing part of the corporate debt structure? These delinquency rates are pretty much pinned to multi-decade lows. That doesn’t spell imminent doom either.
Last but not least, the entrepreneurial uptick in America is both surprising and encouraging. In the first half of 2023 there were more than 293,000 business applications that included “planned wages.” This indicates a business that will likely have payroll and is one of the widely watched indicators for business startups. This number is up more than 20% from the first half of 2019 which probably isn’t what you were expecting to hear but it is good news for the resilience of our economy.
The Federal Reserve will likely hold tight and not increase interest rates this week at their September meeting. Some market observers are suggesting the Fed will pause now but an increase in November. Almost everyone I know is surprised – really surprised – that financial markets are currently holding together as well as they are. There are lots and lots of problems with our financial systems and the “leaders” running them as well as the “leadership” in Washington DC. But those issues have been building consistently for decades and the markets don’t appear to be showing imminent doom.
For months we have been saying that the negativity of the financial media was overdone. We still think it is. Next week we will take head on the “de-dollarization” thesis that a lot of market commentators are presenting in the financial media. That’ll be fun…
Regards and good investing,
Greyson Geiler