This Day On The Street
Continue to site right-arrow
ADVERTISEMENT
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

Crunch Reminds Investors That Slowdowns Carry a Price

The realization that Sunbeam (SOC), a company once loved on Wall Street and now trading for pennies, might find it difficult to pay off something like $2.4 billion in debt has set off a flurry of worrying among investors.

  • Bank Stocks to Avoid as Credit Worries Mount
  • Junk-Bond Funds Face Growing Risk of Telecom and Tech Defaults
  • Credit Quality Issues Rear Their Ugly Heads Again

    The stocks of two banks that participated in a $1.7 billion syndicate loan to Sunbeam in March 1998, First Union (FTU) and Bank of America (BAC), have fallen under heavy pressure over the past two trading sessions. And inevitably, the market is jittery over the possibility that other banks will see big debts go sour. Particularly hard hit today were regional banks -- outfits like Bank One (ONE), Wachovia (WB) and KeyCorp (KEY) -- which lack the diversity of their larger cousins.

    It's not for nothing that the market is worrying. The Sunbeam loan -- along with this week's Chapter 11 filings from competitive local exchange carrier ICG Communications (ICGX) and bed and bath furnishings maker Pillowtex (PTX) -- has reminded investors that economic slowdowns come with a price.

    Lagging Indicators

    When the economy is flush, as it was so spectacularly until relatively recently, cash is not a hard thing to come by. Everybody is doing well, and there's a feeling that the good times will continue. Creditors become a little less stringent, and loan growth accelerates. Your lay-about brother gets a loan for a new truck, and the corporate equivalents of your brother -- companies like Pillowtex -- get loans, too.

    Credit Trouble?
    Commercial and industrial delinquencies as a percentage of outstanding debt, quarterly
    Source: Federal Reserve.

    When the economy begins to contract, these marginal borrowers are the first ones to run into trouble. Your brother is among the first laid off from the plant (in this particular slowdown, that has so far not happened) and the repo man makes a visit. The Pillowtexes of the world find that they're not taking in enough money to meet their payments.

    Pillowtex is not the only sign. We've seen a sharp fall in the high-yield, or junk-bond, market, which never fully recovered from the 1998 credit crisis. Junk yields are nearly as much above the benchmark 10-year Treasury as they were in March 1991, the trough of the last recession. Commercial and industrial loan delinquencies and charge-offs (debt that's been written off), though not as high as in the early '90s, have been rising steadily. Loan growth is slowing.

    Plunging
    High-yield debt issuance, in millions of dollars
    Source: Thomson Financial Securities Data

    "A lot of this is a lagged response to the easy lending of a couple of years ago," says Lehman Brothers senior economist Ethan Harris. "What you're seeing now is a tighter borrowing environment, so the more marginal borrowers are in trouble."

    Sanford and Son

    So far, it has been the junk-bond market where the tightening credit environment has had the greatest measurable effect. With the ballooning of yields, the issuance of high-yield debt has all but dried up. This has a knock-on effect -- companies that were depending on the high-yield market to finance their way to profitability are running into financing troubles. Particularly hard hit in the high-yield market have been CLECs like ICG and GST Communications, which was also driven to bankruptcy. And those high-profile bankruptcies themselves have hurt the high-yield market.

    "The percentage of distressed issues in the high-yield universe has grown and driven average yields, and thus spreads, wider," says Bear Stearns high-yield analyst Mike Taylor. "About a quarter of the market is now distressed."

    Bigger and Wider
    Merrill Lynch High-Yield Master Index yield,
    with spread vs. 10-year Treasurys
    Source: Merrill Lynch

    Many blamed a poor credit environment for the last recession, and investors who were around for that are probably a little worried. Most economists reckon things are not so dire.

    "It's a bit early to say there's any kind of credit crunch," says Barclays Capital senior economist Henry Willmore, adding that "whenever the economy slows, concerns about credit quality naturally come to the forefront."

    Tailing Off
    Year-over-year loan growth
    Source: Federal Reserve

    But just because there isn't any kind of systemic risk doesn't mean that equity investors shouldn't be wary. As the economy continues to slow, there will be more companies that will fail to meet payments, more defaults, more bankruptcies. More bad days for the firms that made those dud loans.

    "I don't think that it's anything near enough to cause a recession," says Goldman Sachs senior economist Jan Hatzius. "But as an equity investor what you're interested in is whether credit quality or loan quality is improving or deteriorating. It's probably deteriorating."

    Select the service that is right for you!

    COMPARE ALL SERVICES
    Action Alerts PLUS
    Try it NOW

    Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

    Product Features:
    • $2.5+ million portfolio
    • Large-cap and dividend focus
    • Intraday trade alerts from Cramer
    • Weekly roundups
    TheStreet Quant Ratings
    Try it NOW
    Only $49.95/yr

    Access the tool that DOMINATES the Russell 2000 and the S&P 500.

    Product Features:
    • Buy, hold, or sell recommendations for over 4,300 stocks
    • Unlimited research reports on your favorite stocks
    • A custom stock screener
    • Upgrade/downgrade alerts
    Stocks Under $10
    Try it NOW

    David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

    Product Features:
    • Model portfolio
    • Stocks trading below $10
    • Intraday trade alerts
    • Weekly roundups
    Dividend Stock Advisor
    Try it NOW

    Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

    Product Features:
    • Diversified model portfolio of dividend stocks
    • Alerts when market news affect the portfolio
    • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
    Real Money Pro
    Try it NOW

    All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

    Product Features:
    • Real Money + Doug Kass Plus 15 more Wall Street Pros
    • Intraday commentary & news
    • Ultra-actionable trading ideas
    Options Profits
    Try it NOW

    Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

    Product Features:
    • 100+ monthly options trading ideas
    • Actionable options commentary & news
    • Real-time trading community
    • Options TV
    To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
    Submit an article to us!

    Markets

    DOW 17,888.02 +83.22 0.47%
    S&P 500 2,070.53 -0.12 -0.01%
    NASDAQ 4,766.3340 +0.9540 0.02%

    Brokerage Partners

    Rates from Bankrate.com

    • Mortgage
    • Credit Cards
    • Auto

    Free Newsletters from TheStreet

    My Subscriptions:

    After the Bell

    Before the Bell

    Booyah! Newsletter

    Midday Bell

    TheStreet Top 10 Stories

    Winners & Losers

    Register for Newsletters
    Top Rated Stocks Top Rated Funds Top Rated ETFs