Friday, December 16, 2022

Debt as a millstone around our economic necks

 

We've spoken on several previous occasions about the danger of debt, and how it's dragging down our entire economy.  Debt is not just private (you and I);  it's also corporate and state, with not just the federal government, but a large number of states deeply indebted to lenders, and struggling to repay and/or refinance that debt in the face of higher interest rates.

The new, higher interest rates threaten to cripple many major corporations - and those who work for them.


Interest rates are MUCH higher across the board than they were two years ago.

Residential mortgage rates have climbed from 2.75% to 7.32%. The US 6-month Treasury was just 0.03% last summer. Today it’s 4.75%.

And corporate “junk bonds” yielded as low as 3.8% last year. Today those junk rates are nearly 10%.

That last point is really important, and I’ll give you an easy example. We all know how the cruise industry struggled once the pandemic hit, and those struggles continue today.

Carnival Cruise Lines is hurting so badly that the company’s ‘gross profit’ is negative, meaning that it costs the company more to operate their cruise ships than they generate in revenue.

In Q2, for example, Carnival generated $1.2 billion in cruise revenue. But they spent $1.7 billion on fuel, food, crew salaries, etc., resulting a NEGATIVE gross profit of -$500MM. And that’s BEFORE paying for corporate management, administrative expenses, etc. (which totaled another $400 million).

And it’s also before Carnival paid a single penny of interest or principal on its debt.

They’re clearly in a tough spot. And it was even worse last year and the year before.

Yet Carnival has been able to keep the party going by taking on debt; its total debt is now nearly $30 billion, up from less than $10 billion in 2019, pre-COVID. That’s a lot of debt, given that Carnival’s total equity is only around $8 billion. So it’s ‘debt to equity’ ratio is nearly 4:1.

When rates were still low and their business was somewhat healthy, Carnival was able to borrow money at just 1%.

But now that their business is in the dumps, and interest rates have increased substantially, Carnival is borrowing money at 10.5%.

Remember, the company doesn’t even make enough money to pay its 1% debt, let alone 10.5% debt.

And what’s worse is that these bonds will eventually need to be paid back; in the next 12 months alone, Carnival will have to repay nearly $1 billion in debt. And they simply don’t have the money.

This is a classic distress situation. And it’s no wonder that investors have been dumping Carnival bonds.

But it’s not just Carnival, or even the cruise industry. You’d be surprised at how many companies are in a similar situation — heavily in debt and unable to pay. They’re basically walking dead, which is why they’re commonly referred to as ‘zombie companies’.

Zombie companies have been with us for years; they’ve only been able to survive thanks to cheap interest rates and government bailouts.

But, again, financial conditions have changed dramatically. And if interest rates stay high (or go higher), I think it’s likely that we’ll see a wave of bankruptcies and asset sales, possibly over the next 12 months.


There's more at the link.

As the author notes, "it's not just Carnival, or even the cruise industry."  There are probably thousands of companies who are currently finding it difficult to refinance debt they originally incurred at much lower interest rates.  There are tens of thousands of home owners who took out adjustable rate mortgages, and who are now staring down the barrel of massive increases in the interest rate they're paying.

If you work in a company or organization affected by this, pay careful attention to how it might affect you.  If your state has to pay much higher installments on its debt, what might happen to state workers?  If a company has to pay much higher installments, what might happen to at least some of its employees - perhaps entire plants or production lines?  Will your job be safe?

Of course, there's also the personal angle.  Are you carrying a high credit card debt load?  Credit card interest rates are already usurious, several times higher than a typical bank loan.  I've heard that some credit cards, particularly for those with poor credit ratings, are now at 30% or higher.  If you can't afford to pay them, that's your problem.  The credit card issuer is going to sue for his money, and you're in his crosshairs.

(Oh - and if you've booked a cruise on Carnival or any other cruise line over the next year or two, keep a careful eye on the company's financial situation.  You don't want to be stranded at sea or in a foreign destination, because the company can't afford to get you back home again!)

This is a really serious issue.  Do, please, pay attention to the many ways it might affect you personally.

Peter


11 comments:

Rick T said...

That report was strangely focused on Q2 of last year, or April to June. but doesn't mention the other 9 months of the year, nor does it compare the results to previous years. Did Carnival end the year with a net profit overall? Historically is Q2 a bad quarter?

I work at a small company that is EXTREMELY transparent about operations, and we regularly have months (and sometimes quarters) that are a net loss yet we end the year with a good net profit.

High interest rates are a drag on the entire economy, but that article could have been been better written.

Rocketguy said...

Carvana and similar outfits are likely in a similar situation due to the used car price crash. Lots of inventory that’s worth way less than they paid for it.

Unknown said...

What happens to the credit card companies when everyone defaults on their credit card debt? Will they sue everyone? Good luck. We live in a country full of people with debt and no sense of personal responsibility.

nick flandrey said...

Despite being debt free for the last 15 years, my wife and I had a chance to by a place in the country to use as a BOL and weekend getaway. The place needed a LOT of infrastructure and "foundational" repairs, which is one reason it was affordable to us.

We had no problem with the purchase, having saved for years for just such an opportunity. BUT. That used up the majority of our ready cash. And we still needed $80K to do stuff to make it livable. Given current pressure to have somewhere outside cities to go to if things get worse, we decided that the work needed to be done as soon and as quickly as possible.

We got a home equity line of credit with an adjustable rate the WEEK before the Fed started raising rates. At the time, we took the adjustable rate because we got a discount interest rate if we did.

The discount was more than eaten up by the rate increases since, with our rate going from ~3% to ~7% over 6 months. That's a big change.

And while it would be concerning for a long term loan, the HEL was only intended to be a short term loan, covering construction and repair costs until end of year distributions that we expected to cover the loan.

And they did, so we paid off the HEL this week.

We are once again debt free, we used the credit line as it was intended (short term borrowing against future income) but it was a bit nerve wracking watching all the increases these last few months. Anything can happen, the distributions could have been reduced, either of us could have been injured or killed or gotten a major illness, or the problems we were fixing could have exceeded our ability to fix or pay for them in a timely manner.

There are always risks involved in any human activity, but cautious and well considered plans can reduce those risks. Borrowing money to make physical improvements in your life or living situation is just one tool you can use, especially if it mostly moves money availability forward in time.

I'm glad we did it, and I'm glad we are done with the loan.

n

Jonathan H said...

I got a credit card offering "only" 23% interest recently, like it is a good thing...
The company I've been with for years is currently at 6.5%, which I expect to rise soon.
I pay my card off each month, so the rate doesn't affect me much.

You have a good point about corporate debt, and also mortgages - despite claims to the contrary, we are effectively already in a recession and higher debt costs are going to make it worse.
I wouldn't be surprised to see another wave of foreclosures similar to 2008/2009, especially in some where real estate has been hot.

Jonathan H said...

I wouldn't be surprised if it also hits Tesla and other trendy manufacturers who have been treated like internet companies.

Old NFO said...

Not surprising given the inflation and .gov attempts to bring it under control by raising the interest rates.

James said...

In 2008 in Michigan the auto companies ended their multiyear orgy of overtime for their workers. The massive amounts of overtime raised many factory rats to an upper middle class income level. Unfortunately, in an all too human way, every penny of the extra money was spent on luxuries in the apparent belief that the situation was permanent. When the overtime disappeared, vacation cabins, boats, snowmobiles, off road vehicles, etc suddenly went on the market cheap.There was a rolling tidal wave of bankruptcies.
Now the luxuries aren't there so much and we are seeing the debt vulture coming home to roost. The stats say about 70% of Americans are struggling to pay for food with all of the other inflationary boosts in costs. The non-preppers won't become preppers because they can't even pay their bills now. Those who lived below their means when the money was good will be in much better shape in our dystopian future.

Fredrick said...

Could "Sovereign Man" fill us in on which regions Carnival operates in, where that debt load is funded from, the currency and bond covenants applicable to each? That would be rather useful in performing an analysis. Isn't there a war somewhere in Europe affecting fuel costs and middle-class disposable incomes that might affect cruise ship operations?

Hopefully the info they put out about alternative citizenship and foreign residency are a bit more detailed.

Michael said...

Sovereign Man is a private company that sells useful information to people.

Respond to their ads and spend a little fiat money, you should be pleased at their work.

I am one of their pleased members.

Fredrick said...

Michael,

You mean they don't want to be paid in bitcoin or crypto? LOL