Concern About Bond Defaults Signal Financials Not Out Of The Woods

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The bets that companies will default on their debts is rising. Financials which own junk bonds or have financed junk deals will be on the hook. One S&P executive told Bloomberg “The markets are pricing in a default rate of 9 or 10 percent for high-yield corporate debt, which is a lot higher than we’re forecasting." The rating agency thinks the level of companies not making the note could be over 5% by early next year, so the market is guessing that S&P is wrong on the wrong side of things

Credit agencies don’t have much credibility left. They screwed up their evaluations of subprime assets and kept Aaa ratings on monoline insurers for too long.

The default rate at companies could take a sharp move up for several reasons. One is that companies like Charter (CHTR) and Level 3 (LVLT), which have massive debt and poor operating income, cannot turn to banks and brokerages for either more money or restructuring of their balance sheets The window is closed.

A recession will drive down sales at over-leveraged companies. As their sales fall sticking with covenants is going to become much harder.The airline and mid-level banks have a lot of exposure here.

Auction-rate securities are showing up on an alarming number of company balance sheets. Those will be written down and will hit P&Ls, but, worse, these firms will not have access to that money. A firm with debt problems would like to have access to all of its assets.

The big trouble in the financial markets are not over when the bets on defaults are at tremendous levels. Someone will have to pay for the over-extension of credit. That "someone" is likely to be banks and investors in common stocks in the companies with debt up to their eyeballs.

Douglas A. McIntyre