How worried do we need to be about corporate debt and the repo market?

by failarmyworm

There is a lot of uncertainty right now because of coronavirus: how is it going to further affect supply chains, how is it going to affect mobility and productivity, how long is it going to take, etc. However, I think in general people are fairly confident that once proper measures are in place we will get it under control (as in China, South Korea) and that certainly once a vaccine is available things will become mostly normal again in the domains of public health, shipping, etc.

Still, a large part of the market response seems to be due to uncertainty beyond coronavirus – there is a lot of talk about large amounts of corporate debt which is at risk, and issues with the repo market also seem to make people uncomfortable because it’s not well understood what’s going on. The sense I get is that while the coronavirus issues themselves are likely to be transient, they could trigger systemic issues that might affect us for longer, similar to how in 2008 the housing bubble had far-reaching effects.

What I’m having difficulty grasping is how large these issues are. Back in October the IMF warned that an event half as severe as the GFC could put 40% of corporate debt at risk. Current issues with oil are also raising such concerns as many shale oil companies are likely to take a hit due to low oil prices and often have a lot of debt, which could trigger further issues with banks that are tightly connected to these companies. How does this compare to the situation pre-2008, are we at a similar level of risk? Or does the very fact that we are aware of these issues make them less likely to cause problems? (E.g. because central banks can immediately take action in support of companies with credit issues.)

I’m curious to get a more quantitative sense of the risks here, and also a sense of what the spread between worst case/best case could be. Any thoughts, inputs, advice on sources to consult about this?

 

Comment:

The oil war alone is enough to take down the junk bond market between defaults and downgrades from BBB oil companies. For perspective, the junk bonds market is around 1T right right now. There are 400B in BBB oil bonds. The junk market cannot support that level of debt if it is downgraded. It would take down the whole market.

And then on top of that we have Mexican bud light virus crashing everything too and blowing out spreads as well. Could get extremely ugly.