Are credit concerns a canary in the coalmine?

US credit markets have delivered strong returns this year.

Companies have been issuing record amounts of debt, borrowing costs have remained manageable and bond investors have pocketed solid gains.

It’s been a golden run. However, in recent weeks cracks have appeared beneath the surface, and the pace at which the problems have emerged is worth paying attention to

If you prefer to listen to a podcast episode on this topic: 

Several high-profile corporate failures have unfolded with startling speed.

Luxury retailer Saks made one interest payment before restructuring its debts, subprime car lender Tricolor Holdings collapsed into bankruptcy amid fraud allegations, while auto-parts maker First Brands blindsided lenders.

These businesses operate in different sectors but the common thread is that their corporate health didn’t gradually decline.

They went from seemingly fine to deeply troubled in a matter of weeks, catching even professional investors off guard.

The losses have been severe too, with some bonds falling by 60 per cent almost overnight.

Banks that lent to these companies have also taken hits.

JPMorgan wrote off $170 million because of Tricolor, while investment bank Jefferies has seen its share price fall more than 20 per cent in the last month on the back of its exposure to First Brands.

Regional banks have felt the pain as well, with some reporting loan losses and discovering they’d been victims of fraud.

As these concerns have grown, investors have sold riskier securities and headed for the safety of government bonds instead.

This echoes the US regional banking crisis of March 2023, and this period is a useful guide to how financial markets might react if these concerns worsen.

Turbulence across interest rate markets was a hallmark of that period, with the US two-year Treasury yield experiencing its biggest daily decline since 1982.

In contrast, sharemarkets were relatively calm and the turmoil blew over quickly.

It’s unlikely a financial crisis is brewing this time either, with the US economy still growing, companies still hiring and most businesses doing fine.

But a long period of modest interest rates and steady returns might’ve made investors a little too complacent about risk.

When you buy or invest in a bond or fixed income security, you’re essentially lending that entity money.

When borrowing costs are cheap and returns are hard to find, investors often start reaching.

They buy corporate bonds that pay only slightly more than government ones, and agree to terms that offer less protection.

A raft of legal clauses and covenants used to be standard, although some lenders have been paying less attention to these in recent times.

This isn’t a problem when the going’s good and defaults are rare, but when something does go wrong these missing safeguards matter.

That extra one per cent of interest doesn’t look so clever when you’re facing a capital loss.

Another big problem has been a lack of transparency.

Many of these troubled borrowers are private companies, which means they don’t face the same scrutiny as publicly listed ones.

Many investors wouldn’t have gone to the trouble of understanding Tricolor’s complicated operations, while First Brands wasn’t particularly revealing.

While things kept ticking along, nobody asked too many questions.

US corporate bonds are on track for a strong year in 2025, as credit markets have still performed very well overall.

The flood of incoming money that’s helped drive those returns has also encouraged the kind of careless behaviour that can lead to blow-ups.

This pattern will be familiar to New Zealand investors.

Between 2008 and 2011, we watched our own finance company sector implode in much the same way.

Companies with opaque business models attracted investor capital by offering high returns.

In the finance company days, investors (who were lenders to these entities) chased those attractive rates but didn’t ask enough questions.

It worked we’ll for a while, until the whole thing came crashing down.

I don’t think we’re heading for a similar situation in the US today.

First Brands and the like look more like isolated failures, rather than the beginning of something bigger.

But the recent market jitters are a useful reminder that when credit problems emerge, they move fast.

Most of the time, it pays to stay calm rather than get prematurely pessimistic.

But we should still ask ourselves whether we’re being paid enough for taking the risk that this time might be different.

Market Insights enewsletter

Keep up to date with our fortnightly Market Insights enewsletter. Our research team provide timely and regular commentary and analysis on market developments, understanding investment jargon, and the impact of current events.

Subscribe Now