Hello, and welcome to The Credit Edge, a weekly markets podcast. My name is James Crombie. I'm a senior editor at Bloomberg. Today's guests are Jeremy Hill, who reports on distressed debt for Bloomberg News in New York. We're delighted to have you on the show.
Hi, thanks for having me.
We're also very pleased to welcome back Jamin Patel, who covers utilities for Bloomberg Intelligence.
Good to join, James.
We'll be coming back to Jamin shortly. Lost of exciting stuff going on in the utility sector, so do stay with us. But first, Jeremy Hill, with Bloomberg News, you've been digging deep into distressed debt and bankruptcy. We've had the pleasure of working together on that for years. A lot of companies are running into trouble at the moment, with interest rates rising and the economy slowing, potentially tipping into a recession. Volatility in the financial sector doesn't help.
Regional banks are struggling, and that means less for the companies that really need it. On top of that, we have a growing anxiety about the debt ceiling. I'd have to go back to twenty eleven for the last time it's been this fraud. A debt default by the US government would be a huge and potentially catastrophic event for the global economy. So, Jeremy, why the big spike in bankruptcies right now?
That's a really interesting question, James. I think what's so fascinating about this uptick over the weekend is that there isn't any one factor that caused it. There wasn't some sort of acute influence like in twenty twenty COVID. It was something that nobody really saw coming. It was something like a rogue wave that just pulled down a bunch of companies that were already on the edge, and then it receded and things got back to their you know, abnormal.
But this time, interest rates are just starting to bite and it's very organic, and it is while interest rates increased relatively quickly, it's just such a fundamental problem for anybody that is exposed to floating rate debt.
So the context, Sorry, just to interrupt this past weekend we're talking mid May. Now. It was the busiest weekend for US bankruptcy filings since when and how many were there?
There were seven filings between Sunday and Monday, and those are seven large I'm doing air quotes filings that we define that to be fifty million dollars of debt or more. And it's just not something that we have seen in the roughly fifteen years that we've at Bloomberg have been tracking the data. A really busy couple of days is like three or four large bankruptcy filings. So these filings were across various sectors. There was some oil, some healthcare.
There was a fire protection company, a company that makes like the smoke detectors and chemicals to put out fires. I mean, it was really across the spectrum. And the only thing that really unites almost all of them is that interest rates are higher now and lenders don't have the patience that they once did.
So were they hitting a maturity will that was there a trigger in terms of, you know, you have to pay this debt by the weekend and if you don't, you go bust? I mean, what what what happened there?
In the case of Envision, that was in Vision Healthcare is a KKR backed company that does physician staffing. Mostly they like provide doctors for medical practices, is my understanding. They they had some sort of debt payment that they needed to make recently, but that wasn't like all of the It's not that like all of these companies were
running into imminent maturities. It is more so that these are companies that were kind of struggling, had been for a long time, really didn't have any hope of repaying their debt load. And now that the economy is not so great and interest rates are higher, lenders are not taking the time to be like, let's try to work out a deal or extend the runway a little bit more, see if we can find a way to turn it around. It's more just like game over, guys, it's time to move on.
And none of these names was surprised to us, right, We've been tracking a lot of these situations for a long time. I think all of these have been on our calendar.
Yeah. I mean there were a couple that we didn't that we didn't see coming, the fire protection company, and there was a small biopharma company that makes cancer therapies that weren't necessarily on the radar, but mostly they were. I mean, these are the other companies. Some people might call them zombies. Maybe it's an overused term. But these were companies that I mean, the writing has been on the wall for a long time. They just had so much debt and it was difficult to see them ever
being able to pay that off. The question was just when will time be up?
So they've been just kept alive by this you know, flood of cheat money that we've seen over the last ten years, and that finally ended, so they died. Is that right?
Absolutely? I mean, if you're a lender to one of these companies and even you know that they're not going to be able to fully repay this stet load, but interest rates are super low and you need yield, and you don't want to be dealing with it with a default, with a bankruptcy. Why not come with some really creative way to extend the runway. It's a it's a lottery ticket, it's it's it's a chance. But interest rates are higher, you can get yield elsewhere. Now it's time to move on.
And that's not just a flash in the pan for this year. Right, This year has also been very busy for bankruptcies. How does that stuck up us his history?
Yeah, it's already quite busy. I mean, the numbers, the precise numbers are escaping me in terms of the level of filings, but I can tell you about the pace relative to the historical levels. We're having about the busiest year for large bankruptcies that we have seen since two thousand and nine. Two thousand and nine wasn't a very happy time, so it's a little bit dark. But I will say this, we're still nowhere close to that two
thousand and nine pace. It's usually it changes week to week, but it's usually about half as busy as two thousand and nine and just about as busy as twenty twenty. They sort of change places sometimes, but it only seems to be getting busier. We're seeing more and more filings.
So it's as bad as the twenty twenty shutdown of the entire global economy, which really did throw a lot of companies against the wall.
Yeah, that's exactly right. But as I said earlier, this time it's a it's more organic. It's not some wild rogue wave that was caused by, you know, a fatal virus. This is simply money is more more expensive now, the economy is a little rickety.
So neither of those things seem like they're going to change anytime soon. If anything, rates probably stay higher for longer. The economy is not in great shape. Does that mean this trend continues? Does it get worse from here?
For sure? I mean I haven't I haven't spoken to anyone recently who is under the impression that this building distress is just going to disappear. I mean your default forecasts, Ferry. Some people are extremely bearish, think that there are going to be tons and tons of filings, it's going to be a big tsunami. Other people are more conservative, but the general consensus is up more defaults, more bankruptcies.
And what does this say about the broad state of credit markets? I mean, we've been talking for a long time about a credit crunch, the easy money era being over, and as we've said, companies have too much debt. Is this really the beginning of the end.
If you're a low quality borrower, you're going to have a hard time refinancing your opplique or getting reasonably priced debt. It is as simple as that. And there are a lot of low quality borrowers out there, so I would say that's that is the biggest takeaway so far.
Is it isolated to a particular sector? You know, last time around, we saw a big retail crunch. We've seen energy get hit pretty hard in the past, but is you know, healthcare is also kind of undistressed. But are there any sectors that really stand out?
You know, retail, We've seen a couple of retailers run into trouble this year, but a lot of the crummy retailers were shaken out in twenty twenty years before. Healthcare is a sector that comes up a lot because wages have been a big problem broadly in the healthcare space. So if those don't come down soon, you're going to see more trouble in that area. And of course, real estate, especially commercial real estate, just tons of debt and offices are not filling up the way that they need to
to support those debt levels. So healthcare cri that they're coming up a lot.
The word you use in your piece is zombies. That's an interesting concept. I mean, these companies, you know, they're sort of living dead. They're sort of stumbling through with you know, cheap money keeping them alive, but there is no reason for them to live. I mean, we may have an emotional attachments to companies like bed Bath and Beyond and Radio Chat for various reasons. And obviously there's a loss of jobs and there's a big impact on communities.
But you know, in you know, harsh, you know there capitalistic terms, do we really care about their demise?
Yeah, this is really interesting to me. I was speaking with Ed Altman, who is a pretty famous finance professor at NYU. He invented something called the Z score. It's a default prediction metric, and I asked him. We were talking about repeat bankruptcies, so called Chapter twenty two's, and I asked him, like, why does it matter if companies keep failing over and over again? Like who cares? The people stay employed and you know, we get to keep
going to some some retailer that we like. And his take on that was, this is money and time and energy that could be put into more productive endeavors. That's why it matters. I thought it was fascinating. I haven't thought about it like that. So these these are these kind of zombie companies that maybe don't really have a
reason to exist. The people that are taking care of these firms and employed by them, it'll be painful for them to disappear or shrink substantially, but it may be more productive overall to shift those resources that are propping up something that just shouldn't be alive in its current form and moving them into some other area of the economy.
So short term pain, but maybe long term game for the US economy. But you mentioned repeat bankruptcies. I mean, as we call them chapter twenty twos, that just seems like a waste of time. I mean, you know, is the bankruptcy system really working in this country?
Such a good question. Yeah, I mean, we have seen more chapter twenty twos again, in line with the general rise in bankruptcies, more chapter twenty twos this year than we've seen since two thousand and nine. And what does it say about the bankruptcy system. I mean, it's a little bit embarrassing because in the US, restructuring plans aren't supposed to get approved by a federal judge unless there's some specific language. But the general idea is that you
need to not go bankrupt again. It needs to be pretty clear that this plan is going to fix the company's problems, because the bankruptcy court can do all kinds of things that you can't get anywhere else. You can just reject leases, you can force people to accept less than their owne all in the name of restructuring a company. So it's not great. It doesn't mean the bankruptcy system is broken. But seeing an uptick in repeat filers is it's it's ugly. You don't love it.
It's supposed to be the best system in the world. But that's that's that's an interesting statement. But before we talk to jam and platel Boomberg Intelligence, what's the next big story to watch on your beat? Jeremy, what else do we need to worry about?
What is the next big story? That's a hard one to answer, James, because all of a sudden, we've gotten so busy that I feel like I'm treading water. This is this is the thing that we have been waiting for. It's it's it's felt like when are rate's going to go up? And what is that going to mean? And kind of out of nowhere here it seems like the mood has just flipped and there are lots of companies
that are that are on the cusp. Lenders are organizing all the time and they're concerned about their debt holdings. So the big story is, uh, stay glued to your terminals at Bloomberg dot com because there are many more markruptcies to come.
Great stuff. Jeremy Hill from Bloomberg News, thanks so much for joining us. Do as Jeremy said, read all of his scoops on the Bloomberg terminal and of course at Bloomberg dot com. Moving on to another big topic. As I mentioned earlier, we are very fortunate to have with us Jamin Patel, who looks at utilities for Bloomberg Intelligence. What's going on with utilities?
Jam in?
Tons of bad news out there is Jeremy's just outlined for us. Shouldn't we just be taking all our cash and keeping it in a mattress right now, or at very least in an easy access saving his account with a five percent yield? I mean, why should we be looking at utilities?
Well, that easy access account may give you a five percent yield, but how long is they're going to give you that for? Right? If reads start coming down and I'm not calling for indecline anytime soon, but if they do, then you want to start looking at something that you can tie your money up in for a little bit longer. And that's why utilally bond. A lot of people would say utili stocks too, but we'll talk about the differences
between those two. It's interesting that, you know, we started this off talking about bankruptcies, because bankruptcies in the utility sector and one of the reasons why the sector, at least at the operating utilities level, is considered a refuge during times of turmoil. We've had very few bankruptcies. They've always been related to something very specific going on as opposed to what happens with the sector as a whole.
In fact, I beyond the pg and E bankruptcies which we're all familiar with, I can only remember in the thirty years I've covered this sector Public Service in New Hampshire and Texas New Mexico Power, and in both those cases, bondholders came out whole, and the same with PGEN. In fact, with PGNE, bondholders weren't secured at the utility level and they came out secure.
Other than those companies. Just my, what what are we talking about in utilities? Because it does cover a huge range of companies, right it does?
It does? You've got you know, over over one hundred different utilities around the country. Uh, most of them are fall on the investor owned utility sector. And then you've you've got the you've got the holding companies. Now, if you're down at the operating utility level, imagine you know, you're in a situation where you have a monopoly in
your service territory. Your rates, the rates that you charge your customers, and therefore your revenues and your earning stream based on a return on equity is almost guaranteed, regardless of what the usage is, what weather impact there is,
and so on. Uh. In the event of a crisis, as we saw with Hurricane Katrina in New Orleans, we've seen with fpn L in Florida, we saw in Houston with CNP, if your assets are destroyed or or very heavily damaged, you have the right to have an adjustment made your rates to cover those costs over a period of time. UH. And you can go out and issue debt in the meanwhile, right, So you had you know, PGIN was very much a one off sort of case
in my opinion. But you've got the situation where at the operating utility level, you've almost got a quasi treasury type of bond.
So as you say there are a refuge, we are saying great economic financial turmoil right now. So in terms of you know, the utility picks. You know, what what do you where do you look in terms of like what types of utilities? You know, where do you look? What's what's the best place to be in right now?
Okay, So with that safety comes a price, and that's generally lower yels, right as you would expect. And at the operating utility level you've got, you know, you've got a fair narrow range depending upon the maturity that you're looking at a narrow range of bond spreads. So the real interest tends to come in and the real credit risk tends to come in at the parent level, right because the parent itself is not regulated. It's reliant on dividends coming up from the utilities to service both the
shareholder dividend as well as to service its own debt. Now, if you have a parent with what just one utility, clearly that's that's a high risk situation, right. So and that's what we had with PG and E. What investors see with Edison International. If you if PGN owned more than one utility, the parent may not have had quite the same problems that it did. But in this case,
the parent filed for bankruptcy. So what we look for our companies that have multiple diverse utilities operating across multiple jurisdictions, Companies like Excellent Duke Energy, American Electric Power, and so on. These these are companies that do rely on the dividends coming up to the parent to service their debt. But in the event that you have a situation at one particular utility, you still have cash flows coming up from the others.
So you're looking essentially for diversification.
Yes, across jurisdictions as well as geographies.
Okay, but you mentioned there are credit risks. Are you concerned about liquidity or access to capital markets there?
Certainly not at the operating utility level. At the parent level, one of the concerns we've seen is that as we've enter this period of high growth, largely driven by renewables and perhaps accelerated by the Inflation Reduction Act, there's been a significant amount of capex projected and actual down at the utility level. Now, that comes with borrowing. Right now, if you think of traditional utility, the way they've financed their capex and investments is approximately fifty percent debt and
fifty percent equity. Now that equity comes from retain cash flow. Right If the capex is higher than you expect. Where is that additional equity going to come in from. We've seen in many instances it's a reduction in dividends that would go up to the parent, and we've actually seen equity coming down from the parent level. Right So where does the parent get that cash? Utilally generally don't issue equity. They tend to be very e retician to do that.
Although we've seen a little bit of convertible equity being picking up a little bit here, but they don't buy that back there stocks either. They just don't have the cash flow to do that. So what we've been seeing is an increasing level of parent debt and that raises a little bit of a concern. Right now, where does that concern come in? It's if you're looking at purely statistics, credit statistics and regular metrics like leverage and debt service and so on, yes, then it's a little bit of
a concern. But we did we did a little bit of a study recently where we looked at across the entire sector. We looked at the book equity of the operating utilities, took a multiple of that based upon where these have traded or sold or where pieces of them have sold recently, which was about a two times multiple.
That gave us almost a trillion dollars of equity. Potential equity that can be released and released not in the sense that the utility would have to go in and the parent would have to go in and sell that utility. They're able to monetize pieces of this and we've seen that happening with First Energy Douke Energy recently where they've sold pieces of their subsidiaries uh to to pay down debt at the parent level.
And listeners can get that. So they they look up your bio on the terminal, can they change?
Yes, Yes, it's in. It's in something that I called over nine hundred billion equity value could drive utilities firepower.
Okay, well look that up, thank you. The other big concern right now is rising interest rates. How does that affect utilities in comparison to other sectors.
So, because utilities are regulated and all of their costs or most of their costs based upon how the regulators view them and whether they approve them or not, are passed through, right, So if you've got any short term debt that's floating, you can apply for that to be passed through as an increation rate. Most of their death though, is fixed. Right. Utilities are very very big borrowers, but they tend to and they are able to borrow for thirty year bonds. So a lot of their debt, at
least at the operating level, is thirty year bonds. So in the immediate term they are perhaps more protected from higher interest rates than pretty much any other sector.
But on the flip side, if you're a holder, you've been hit pretty hard on the duration.
Right, yes, But then that's you know, pretty much any sector, right if you're going to own a twenty or thirty year moond in technology or banks or where have you. So that's the choice pot hold the right and the risks that they run pretty much in any sector.
So if you're looking at just sort of you know, the big picture now as we're heading into potentially a recession, you know, potentially stagflation, there's all sorts of other big risks out there. Is the utility sector a hedge against this? Is it something that you can just you know, protect your your returns with and clip the coup? I mean, how do you how do you envisage it as a big part of a credit portfolio.
Yeah, so I don't know if I would call it a hedge, but I would I would say that if you want to look at increasing your waiting to protect your portfolio from volatility, then that's something that you may want to consider, right. You know, Perhaps the biggest risk that we've got here, other than what I talked about at the holding company, is that as you go through inflation, customers are being hit on multiple fronts, right, and less
able to afford increases in the utility bills. Now, if you go back several years when natural gas prices was seven eight nine dollars in mcf, and then we saw that decline coming down to two three dollars, it was very easy, or I should say much easier for regulators to allow increase in rates for the energy component excuse me for the delivery component of a utility bill, because the energy portion was coming down, so customer bills weren't
actually going up, right. And then, of course, as we saw natural gas prices rally through the last year, that became much more difficult. Now, regulators usually loath to give rate increases that are in excess of inflation. So with inflation being as high as it is that gives them a little bit more room. Gas prices having come down again gives them a little bit more room for their
transmission distribution. But if you start tee natural gas prices and power prices escalate from here for whatever reason, then rate increases may become a little bit more contentious.
And on the consumer side, no matter how how they get hit by inflation. Mean, you can easily dispense with eating out and buying luxury goods, but you have to pay your utility bills. You need the heat and light.
Right absolutely, and if you can't afford them, that's one you know, this is one sector where low income families can get help from the state.
Right before we sign off, Jamie, I wanted to ask you about ESG because it is such a big topic for investors, and you know, some of these companies aren't the cleanest, there are some issues. You know, How does how does this fit with an ESG credit portfolio?
Well, I think I think it fits in very well because utilities are the biggest issues of green bonds in the in the country as as a sector. If you go back, I want to say maybe ten or fifteen years, coal accounted for fifty percent of the fuel used for generation that is now more a percentage that applies to natural gas, and you've seen solar and wind pick up significantly, So you know, we many of these companies have committed to zero carbon, depending on the time period that's involved.
The government is completely behind them. Nuclear is becoming a bigger factor, a bigger factor from the standpoint. It's not going to decline to the extent that we thought it was maybe just a decade ago, because it's recognized as a clean fuel.
Thanks very much, Jamon Patel of Bloomberg Intelligence. You can read all of his great analysis on the Bloomberg Terminal. Do check it out, and thanks again to Jeremy Hill from Bloomberg News. Read all of his scoops on the terminal and at Bloomberg dot Com. I'm James Crombie. It's been a pleasure having you. See you next week on the Credit Edge.