Is commodity financing the new subprime?

Excellent bloomberg article on banks’/investors’ commodity exposure.

Here are the most interesting quotes,

Yield-hungry bond investors sucked up a lot of the debt that was issued and now hold about $2.1 trillion of outstanding notes. They’ll be first to feel the pain considering Standard & Poor’s has already downgraded securities equivalent to 47 percent of that amount and made some 400 negative-ratings moves in the basic materials and energy sectors over the past 12 months alone. Such scale and depth is reminiscent of the way banks were slaughtered by ratings companies during the 2008 financial crisis.

It’s unclear where the other portion of the $3.6 trillion in liabilities lies but probably, most of it is owed to banks. If the remaining $1.5 trillion is indeed on the balance sheets of financial institutions, that would represent about 1.5 percent of the total assets of all the world’s publicly traded banks. That doesn’t seem very significant, or any cause for concern. But to put it in some context, U.S. subprime mortgages represented less than 1 percent of listed banks’ assets at the end of 2007.

1.5 percent of listed banks’ assets is a significant amount given equity ratios of about 5 percent on average, and taking into account that the bad loans from the previous crisis have not yet been dealt with (curtesy of low interest rates), as evidenced by stubbornly high NPL ratios across Europe.

Also do not forget that these loans are not evenly distributed, but on the books of banks with close connections to the commodity industry. The average doesn’t tell the whole story. Since the modern financial system is based nothing but confidence, one can see how one major player’s difficulties can translate into a financial crisis.

Make no mistake: the comparison with subprime is well deserved,

Five years ago, those companies tracked by Bloomberg had more operating income than debt, on average. Now, it would take them more than eight years’ worth of current earnings, without provisioning for interest, taxes, depreciation or amortization, to clear their combined net obligations.

An average net debt/EBITDA of 8.1 means these are really bad credits. The average energy loan is well worth less than par. Especially since depreciation is a very real expense in an industry where assets deplete rapidly…

One can see the potential…


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