Wednesday, December 17, 2014

The Next Financial Crisis? (excerpt)

Of course, debt defaults are likely to occur among oil producers. But I doubt they will trigger a financial crisis comparable to what happened in 2008 and 2009. Most of their junk bonds are in bond funds. There could be a liquidity crisis in those funds, but the pain will be limited to very few investors, in my opinion.

The cost to insure Russia's five-year bonds has surged to the highest levels since 2009, reflecting fears related to the fact that the Russian government gets half of its revenue from oil and gas exports. Moscow has significant foreign exchange reserves to service its debt. So far, the ratings agencies aren't downgrading Russian government debt. Standard & Poor's reaffirmed Russia's credit rating in October, though it warned of a downgrade over the next 18 months if the government's finances deteriorate.

Venezuela, on the other hand, is in dire straits. Oil makes up 96% of the country’s export earnings, and it stands to get squeezed more because its oil production costs are relatively high. Venezuelan credit default swaps cost five times more than they did in June.

The Bank of America Merrill Lynch high-yield corporate bond composite rose to yield 7.13% on Monday, up 197bps from the year’s low of 5.16% on June 23. The spread over 10-year Treasuries rose to 501bps on Monday, up from the year’s low of 253bps on June 23. That’s the widest since November 20, 2012. This spread is highly correlated with the S&P 500 VIX, which rose to 23.6 yesterday, still well below levels during the current bull market’s previous panic attacks.

Yesterday’s FT featured a story titled, “Oil plunge sparks US credit market fears.” It focused on collateralized loan obligations (CLOs). These “are a type of bond that bundles together cash flows from loans made to highly indebted companies and then slices them according to risk. … Oil and gas loans make up 4.5 per cent of the S&P LCD Loan index by amount outstanding-a proxy for exposure that may be embedded in CLOs. Energy loans make up 4.1 per cent of JPMorgan Chase’s loan index.”

Today's Morning Briefing: Two Shades of Grey. (1) Frackers: America’s patriots. (2) “Drill, baby, drill!” (3) Hurting our natural-born adversaries. (4) Assessing the odds of a new financial crisis. (5) Some German exports hit by sanctions on Russia. (6) Russia has reserves to service its debt. (7) Venezuela is an accident waiting to happen. (8) Stressed-out high-yield bond funds and CLOs. (9) Fed to the rescue again? (10) Flash PMIs mostly muddling around 50.0. (11) Focus on market-weight-rated S&P 500 housing-related industries. (More for subscribers.)

No comments: