Comparing subprime corporate and subprime mortgages

22 May 2013 by Jim Fickett.

The current volume of US corporate debt rated CCC is on the same scale as the volume of subprime mortgages before the last crisis.

The Financial Times quotes SIFMA to say that outstanding corporate debt in the US has grown from $5.5 trillion in 2007 to $9.1 trillion in 2012. Just the speed of that growth is interesting, and worrying, as a rush to lend usually indicates some lack of attention to creditworthiness.

It is particularly concerning that the fastest growth has been in lower credit ratings. As of 2011, 19% of the market was rated CCC (High-yield investors could get burned soon). Assuming that percentage was still approximately correct in 2012, that says the total amount of CCC-rated corporate debt as of last year was about $1.7 trillion. A CCC rating means the debt is very likely to default, even under current conditions.

“Subprime” was never a precisely defined term, and full data was hard to come by, so there are rather different estimates of the volume of subprime mortgages in 2007. An NBC article from March 2007 estimates $1.3 trillion. Edward Pinto, former chief credit officer for Fannie Mae and now a fellow at the American Enterprise Institute, estimates $2.5 trillion.

What is clear is that the volume of CCC corporate debt currently is in the same ballpark as the volume of subprime mortgages before the last crisis, and still growing rapidly.

Of course subprime was not the whole story in 2007. A similar amount of Alt-A mortgages were almost as bad as the subprime. But similarly, CCC is certainly not the whole story now. A much larger fraction of junk bonds than just the lowest rung is at risk.

Further, bank loans to companies are also growing rapidly, and many of these are probably poor quality. The Financial Times notes that C&I (Commercial and Industrial) loans at US banks grew 20% from Q1 of 2012 to Q1 of 2013. The total is still relatively small compared to the bond market, at $1.5 trillion. But these loans are mostly floating rate, so any normalization of interest rates could cause defaults to start rising, which in turn could shake confidence in the bond markets.

Moody's was recently quoted as saying,

What we’re concerned about is what’s being put on today [in C&I]. Based on what we’re seeing, this kind of lending could lead to the next asset bubble or crisis down the road.

I do not know, and no one knows, whether the US corporate bond market will precipitate a crisis. But it is quite clear that there is a very large amount of debt here that will never be repaid. Trouble brewing.