SMALL BUSINESS IS A BIG DEAL
In our recent monthly commentary, we discussed the narrow profits recovery that has been mostly confined to the financial sector. Today we’ll talk about the improvement in corporate credit conditions since the credit crisis hit its peak in the months following the Lehman bankruptcy, and how it seems to be confined to companies with access to the corporate bond market.
Conditions in corporate credit just keep getting better and better. Spreads have tightened to more normal levels, and the absolute yield on investment grade and high yield corporate debt is just about as low as it’s been in 40 years. Not surprisingly, a record amount of junk bonds were issued in March as companies took advantage of the increased risk appetite of investors. “Covenant lite” features like payment-in-kind toggles, which allow companies to make their interest payments with more bonds instead of cash, are even reportedly making a comeback (WSJ subscription required). For companies large enough to have access to the corporate bond market, this loosening of credit has helped them repair overleveraged balance sheets and refinance more expensive debt. However, not all businesses have access to this market. In fact, most don’t. This morning’s National Federation of Independent Business (NFIB) Small Business Optimism Index sheds a little light on the availability of credit to the kinds of businesses that employ nearly half of all workers in the US, according to ADP: companies with fewer than 50 employees.
The NFIB survey, which polls companies on topics like revenues, labor costs, inventories, and employment, fell to 86.8 in March from 88.0 in the previous month. There are many underlying trends in the survey that are interesting, but those related to credit availability stood out the most. For instance, the number of companies reporting that credit was harder to get than last month reversed previous improvements and reverted to previous highs.
Also, the net percentage of companies expecting credit conditions to get easier in the next 6 months fell back to previous lows.
This doesn’t look like a picture of improving credit.
Big companies may have access to capital markets made up of eager lenders with looser standards (i.e.,the corporate bond market), but small businesses are still dependant on the banking sector. And the lending conditions in the banking sector seem to be somewhat tighter than the bond market. Instead of matching the record issuance volumes of the high yield market in March, commercial and industrial loans and leases on bank balance sheets continued to fall, to the tune of $11.4 billion during the month.
““Covenant lite” features like payment-in-kind toggles, which allow companies to make their interest payments with more bonds instead of cash, are even reportedly making a comeback (WSJ…”
tpc, this was a real sloppy commentary by annaly. after reading the wsj article cited and linked to, it is clear annaly doesn’t know what it is talking about.
there is a huge difference among so-called covenant lite provisions between removing financial covenants from a junk bond that piggy backs onto a credit facility and having junk interest pay in kind toggles.
the junk bond holder can forgo financial performance tests because they are in the credit facility, and the junk cross defaults to the credit facility, so the financial covenants are in the junk indirectly. if the issuer pays off the credit facility, it wants to have covenant free junk debt outstanding, and the junk holder says if you can pay off the credit facility, then be my guest.
pay in kind toggles allow an issuer to skip an interest payment and incur negative amortization; this is a huge risk that is nowhere mentioned in the wsj article as making a comeback.
this is a big deal for me, as the reason i got out of the market late 2005 was that i started working on some of these high yield deals with payment toggles, and it was clear they made no sense for anyone but the issuer; things have gotten way too frothy.
there are still plenty of protective covenants in a covenant lite junk bond, just not bank like maintenance covenants.
i was shocked to read this post to discover that payment toggles had come back…now i am shocked to read annaly puts out this stuff without understanding it.
I know you don’t like to read anything remotely bearish on here, but don’t shoot the messenger….Annaly does a lot of great work.
bearish is ok, throwing around terms without understanding them is another thing…also, my post makes clear that i thought annaly was sloppy, not you.
Not sure Chris. Wish I had a better answer for you. I am shocked if a company specializing in the bond market is so egregiously wrong….if so, the editor of this website should be reprimanded!
i got shook up because to be consistent, if the market was doing interest toggles again, i would have to sit things out, and i hadn’t planned on stepping out of the market until about july
Funny how the pundits over at WH and Wall St and tape scream recovery but the small biz owners, under and unemployed (8 mil) feel downright dour if not depressed.
I heard from a friend who made a bundle as small biz broker (restaurants, retail stores, gas stations, dry cleaners) that many of his ex-clients are filing BK and in the midst of foreclosures. Many dipped into the refi and HELOC to maintain or expand the biz. Worst part is that they can’t get much for their small business.