A Mind-Boggling Record in High-Yield Bonds
Americans are still piling on the debt... More signs of trouble in consumer credit... A mind-boggling record in high-yield bonds... The 'junkiest' junk bond in history... A great deal for Tesla and a terrible deal for investors...
Another quarter, another new record for household debt...
Back in May, we noted that U.S. household debt – which includes both mortgages and consumer debt – passed a significant milestone in the first quarter of the year. As we wrote in the May 18 Digest...
According to a new report from the Federal Reserve Bank of New York, Americans have now borrowed more money than any time in history.
Total household debt rose $149 billion in the first quarter of 2017 to $12.73 trillion. As you can see below, this has officially surpassed the previous all-time record of $12.68 trillion, set just before the financial crisis...
Yesterday, the New York Fed released its latest "Quarterly Report on Household Debt and Credit." And once again, it's breaking records...
Total household debt rose another $114 billion in the second quarter. It now stands at a record $12.84 trillion. That's $164 billion higher than the previous peak of $12.68 trillion set in the third quarter of 2008.
And once again, consumer debt led the way. As of June 30, student loans, autos loans, and credit-card debt (revolving credit) all sat at record highs.
Now to be clear, new records in debt don't signal immediate danger. The bubble could continue to grow. It's when debt stops increasing – like it did in late 2008 – that we'll really get concerned.
We can't know exactly when that day will arrive...
But it is clearly approaching.
The Fed's report also showed delinquency rates ticked higher across student loans, auto loans, and credit-card debt. And mortgage delinquencies have now moved higher for the first time since the housing recovery began.
Most notable, the report showed "serious" credit-card delinquencies – defined as 90-plus days delinquent – rose for the third straight quarter, the first time this has happened since 2009.
In a separate report on Tuesday, credit-reporting firm Equifax also noted that the riskiest subprime auto loans are suddenly going bad at a disturbing rate. As Bloomberg reported (emphasis added)...
There's a section of the auto-loan market – known in industry parlance as deep subprime – where delinquency rates have ticked up to levels last seen in 2007...
"Performance of recent deep subprime vintages is awful," Equifax said in a slide show on second-quarter credit trends...
Analysts have been warning for years that subprime car loans pose a threat to lenders as delinquency rates have edged higher since reaching a post-recession low in 2012. But it wasn't until last quarter that the least creditworthy borrowers started to show the kinds of late payment profiles that accompanied the start of the financial crisis...
In other words, we're already seeing cracks in the foundation of this boom. Soaring delinquencies lead to defaults. Sooner or later, these losses cause the credit markets to slam shut. And just like that, the whole bubble bursts.
It's simply a matter of time.
Of course, consumers aren't alone in blowing this bubble...
The corporate-debt markets are just as "frothy."
U.S. companies have already issued more than $1 trillion of new debt so far this year. At this pace, they'll easily beat the previous record of $1.35 trillion set just last year.
Meanwhile, bond investors are practically falling over themselves to buy up even the riskiest of this debt today. In fact, according to a recent report from ratings agency Moody's, U.S. high-yield bonds sold in June contained the weakest lender protections of any bonds issued in any single month on record.
Let that sink in for a moment. "Junk" bond investors are literally taking on more risk than ever before. And today's paltry yields mean they're getting paid less than ever before to do so.
The 'junkiest' junk bond in history?
Our favorite whipping boy is a prime example of the insanity that's sweeping the credit markets today.
Earlier this month, we noted that electric-car maker Tesla (TSLA) was burning through cash at an unprecedented rate. Despite promises to the contrary, we said it was only a matter of time before CEO Elon Musk would be forced to raise more capital. As we wrote in the August 3 Digest...
We often say, "You can fake earnings, but you can't fake cash flows." And Tesla is now hemorrhaging cash like never before...
Tesla sent more than $1 billion to "money heaven" in just three months... which means it has already burned through most of the money it raised from investors back in March.
The company now has just $3 billion in cash on hand, out of a mind-boggling $10 billion it has siphoned from investors since 2012. And yet it's expected to burn through at least another $2 billion before the end of the year. At this rate, Tesla could run out of money as early as the first quarter of next year.
Don't be surprised to see Musk going "hat in hand" to investors again soon.
So we weren't surprised when just a few days later, Musk said the firm was planning to raise another $1.5 billion from investors. But we were shocked he intended to issue bonds, rather than equity and convertible debt, as he has in the past. And we were downright appalled by the terms...
The eight-year bonds – rated deep in "junk" territory by both major credit-rating agencies – were priced at just 5.3%. This is the lowest yield among similarly rated "high yield" bonds in history.
But "investors" weren't fazed. In fact, they begged for more... Musk was ultimately able to raise $1.8 billion, $300 million more than originally planned.
Longtime readers know we've questioned why anyone would willingly buy stock in a capital inefficient company with a failed business model and no hope of ever turning a profit. But at least Tesla shareholders stand to benefit from the company's potential success (however unlikely that is).
That's not the case here...
'It's a great deal for them, which by definition means it can't be a great deal for the investors'...
Remember, bonds are fundamentally different than stocks. As Porter has explained, bonds can't "do OK." They're binary. They either pay back interest and principal or they default.
That's not a minor concern for a company that has never earned a profit and could run out of money within a year.
In other words, the folks who bought these bonds are also likely to suffer massive losses if Musk's grand vision falls short. But unlike Tesla shareholders, they won't earn anything more if he somehow pulls it off. And they're being paid just 5.3% a year for the pleasure.
As Martin Fridson – the "dean" of corporate debt, and the world's foremost expert on the high-yield credit markets – noted to Bloomberg following the deal...
It's a great deal for [Tesla], which by definition means it can't be a great deal for the investors.
The reason they're getting a good deal is because yields are near record lows and risk premiums are much less than they should be. Tesla is taking advantage of that.
We wish those folks the best of luck. They're going to need it.
New 52-week highs (as of 8/15/17): Apple (AAPL), American Express (AXP), National Beverage (FIZZ), Coca-Cola (KO), Procter & Gamble (PG), Weight Watchers (WTW), and short position in GGP (GGP).
In today's mailbag, two readers share their thoughts on negative-interest-rate policy (or "NIRP"). As always, send your notes to feedback@stansberryresearch.com.
"From today's Digest (8/15/17): 'NIRP is like capitalism turned upside down... Instead of being paid to save capital, you're charged a fee just to keep the money you've already earned. At its core, NIRP is simply government theft with a complicated name.' It sounds like the estate tax to me, only you're not required to die." – Paid-up subscriber D. Taylor
"If you read between the lines of Dr. Rogoff's piece [on negative interest rates], you might see that he is saying that quantitative easing and forward guidance are not going to be enough for the next down turn. (He might also be saying their effects are fully incorporated into the economy, so they are not even tools anymore.)
"So, given the past required a cut of 5.5% (on average), about the only 'tool' left in the fiscal policy box, is cutting interest rates even into deep negative rates. But then he mentions that nobody really knows what will happen with interest rates that deep into negative territory (and quotes the IMF!) He is saying bankers have put themselves in a corner. And the only tool left – has never been tried – in these conditions. Three cheers for the FED, and Central Bankers everywhere! I wonder, will I get paid interest on my credit card charges?" – Paid-up subscriber Heinrich E.
Brill comment: You're right. In fact, we've predicted the same thing (but unlike Rogoff, we believe these "tools" are morally repugnant). Should we see another deflationary credit crisis first, the usual strategies are unlikely to pack the same punch this time around. Desperate central banks are likely to resort to more extreme measures, like deep negative interest rates or even direct money-printing (aka "helicopter money").
In other words, sooner or later, all roads lead to massive inflation... and much higher gold and silver prices. And no, we wouldn't count on getting paid that interest...
Regards,
Justin Brill
Baltimore, Maryland
August 16, 2017