Global Credit Crisis 2020 April 4, 2020.


Global Credit Crisis 2020 April 4, 2020. 


https://www.youtube.com/watch?v=W21RzZO3HYk


Entering a deep and synchronised depression 


Companies that have a lot of leverage, increased probability of default - global credit crisis.


What is credit risk?


Whenever an entity lends money, you’ll expect the money to be repaid in full at a date in the future, with interest paid along the way. But the higher the risk, the higher the interest payments. 


If company has a higher credit risk, you’ll be compensate for the increased chance of default, where the company becomes bankrupt - the greater the risk, the greater the return, but the return or yield is greater. 


Why does  a company go bust?


Assets and Liabilities


Liabilities - how do you pay for your assets?

Equity - paid by shareholders

Debt - Bond Issues.


When the price of a company falls that has drop has to be mopped up by the equity, making it decrease, as the debt can’t shrink. Likewise when assets shrink, the equity shrinks, but the debt doesn’t - if the equity shrinks all together then the company will default and it will go bankrupt. 


Conclusion:-so a great way to look at the risk of whether a company is going to go bankrupt is to look at the ratio between debt and equity. 


Gurufocus.com - Ford Motorcompany. 

Total Debt is short term debt 54313 + long term debt. 102408/ Stock Equity 33185 = 4.72/ 


5 Dollars of debt to 1 sector of equity. 


https://www.gurufocus.com/term/deb2equity/NYSE:F/Debt-to-Equity/Ford%20Motor%20Co


Compare to Tesla: 2.14

https://www.gurufocus.com/term/deb2equity/NAS:TSLA/Debt-to-Equity/Tesla


Google is by contrast is 0.8

https://www.gurufocus.com/term/deb2equity/NAS:GOOGL/Debt-to-Equity/Alphabet


Amazon is 1.02

https://www.gurufocus.com/stock/AMZN/summary


Tech companies have low Debt to Equity. Credit risk is extremely low. 


What is Credit Spread?

The compensation investor demand for taking on the risk. 


Many people rely on credit ratings - Moody’s, Fitch, S and P. 

AAA - BBB- is Investment grade. 

BB+ - D is junk bond or speculative investment. 


You can split up the yield on the bond - roughly the income - into several components. 

Investment Grade:

  • Part is the risk free rate (govt bond) 0 credit risk in a developed country. 

  • Credit risk - spread of losing capital due to default. 

  • Liquidity risk - unable to sell it. 


Speculative Grade:


Risk free rate is the same, but credit and liquidity are lower. Less liquid and a higher risk of default. 


Speculative credit is also high yield. 


The ratings change all the time based on market forces. 


End of March 2020. The yield on a AAA = 2.11


Single B at end of March 2020 = 9.99


Yields go up when prices go down, so if yields rise, there’s a sell off in the price of US corporate bonds. 


In 2008 before crash. Single B went up 21 per cent, whereas AAA went up to 6 per cent. 


Why is he worried about a credit crisis now?


Just had a decade of almost zero interest rates,  there’s been a reach for yield, so investors have gone for more speculative credit to increase income. 


Incoming is falling for many companies, which means a lot of investment grade debt could be downgraded to high yield. 


Institutional investors own most of these bonds, many of which are only allowed to investment grade, so they have to sell off. 


When income falls, there’s a credit downgrade, large institutional investors are forced to seal them, which increases the credit spread, the debt replacement cost increases, which means the cost of servicing their debt will be considerably higher and the probability of default increases. 


Downgrades are replacing upgrades by 3:1. This is the highest since the financial crisis. 

Not just a US phenomenon, the rate of default tends to correlate across regions, so likely to be a global phenomenon. 


Shape of Recovery. 

V - Sharp recovery

U - Lengthy recovery. 

L - Permanent Loss of output. 


Timing matters because companies have to rollover their debt. 

JP Morgan estimates that companies will have to rollover of 4.7 trillion USD of debt over the next three years. Considerable proportion of that is speculative grade. 


If this keeps going then there could be a significant recession. 


https://www.ft.com/content/0c13755a-6867-11ea-800d-da70cff6e4d3

China Economic Activity Index. 

Although some elements have bounced back, it’s exports have dropped - worrying. 


US unemployment is probably one of the more timely predictors of a US recession. 

https://fred.stlouisfed.org/series/UNRATE/


https://www.stlouisfed.org/on-the-economy/2020/march/social-distancing-contact-intensive-occupations


There’s a million hairdressers in the USD who are highrisk of getting Covid. No money means they’re more likely to default on the Rent, Utility Bills. Have to buy food. Groceries.


Unemployment could get to 30 per cent. 


Number of new Jobless claims. 

https://www.dol.gov/ui/data.pdf


Bank of England Financial Stability Report highlighted US corporate loan market as being a hot spot also in China. 

https://www.bankofengland.co.uk/financial-stability-report/2019/december-2019


UK Banking sector has a lot of Chinese Exposure. 


France also has a great deal of corporate debt. 


Sounding the Alarm on Leveraged Lending

https://blogs.imf.org/2018/11/15/sounding-the-alarm-on-leveraged-lending/


Shadow banking - part of which is Peer to Peer Lending. 

Shadow banking in China is huge, 8.4 tb dollars. 


Avoiding Leverage. 

High leverage is Peer2Peer lending. 

Low level and liquid - cash - gold - developed market Govt bonds, at a push, large cap, low debt equity. 


You can go here to find quality ETFs:

https://www.justetf.com/uk/find-etf.html?assetClass=class-equity&region=all&equityStrategy=none&sector=none&groupField=none&sortField=yearReturnGBP&sortOrder=asc


Quality ETFs track indices created by MSCI. 



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