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Credit Cycle Ending?


A banking lawyer colleague and I were talking earlier this week about where the credit cycle is and he reminded me that several of the Big 6 Canadian Banks have been laying employees. For example, the Wall Street Journal early this year reported that CIBC eliminated 500+ jobs. Less than a month ago, CBC reported that National Bank cut a few hundred employees. Just last week, Scotiabank announced layoffs, as did Toronto-Dominion Bank for the second time this year.

Could the current credit cycle be coming to an end?

My banking lawyer colleague also said he has seen lending has also been largely limited to companies with the highest credit ratings. This is consistent with what is happening in the U.S., where credit risk has been on the rise given wider credit spreads and more credit rating downgrades. There has also been a decline in high-yield (a.k.a. junk) and leveraged loans borrowing activity.

junk-borrowing-1_2015-10If you click on the first graph from credit rating agency Moody’s, then you will see that for the twelve months ending 3Q-2015, junk borrowing activity (green line) has substantially decreased by 29% from the record-high achieved less than two years ago in 4Q-2013. This may prove to be a problem. Let me elaborate.

Looking closely at the first graph, then you will see that this metric previously set record-highs for twelve-month periods ended in 3Q-2007, 4Q-1999, and 4Q-1989. For those of you who are old enough, then you know that recessions (yellow bars) occurred within 15 months after each of those previous record highs for junk borrowing activity. As you can see, high-yield borrowing may be a leading indicator of recessions.

Though it is true that plenty of high-yield lending has been in the beleaguered oil & gas industry, the difficulties of the junk bond market extend beyond petroleum.

junk-borrow-2_2015-10If you click on the second graph from Moody’s, then you will see the worldwide issuance of high-yield corporate bonds for: 1) oil & gas companies (green line) and 2) other types of companies (yellow line). Twelve-month totals show that the issuance for oil & gas companies peaked earlier this year but has since decreased by more than 40%. As for other types of companies, their issuance peaked in the middle of last year and has since decreased by more than 20% (red dotted circle). In other words, the difficulties of the junk bond market extend across industries.

My banking lawyer colleague’s insight about where the credit cycle looks to be confirmed by data that shows high-yield borrowing is in substantial decline across industries. And if the past is to repeat itself, then a recession in the U.S. is in the horizon, which would mark the end of the current credit cycle. Please speak to an investment fiduciary before making any investment decisions.

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