The debt avalanches. Once it accumulates enough mass, and momentum is not sufficient to stop its collapse, it overwhelms its host, and will come crashing down on the rest of the system, too.
Across the planet, there are hundreds of governments – local, state and national – as well as business and households who are reaching a breaking point. Already drowning in debt, many are about to default on loan repayments, and thus set off a series of debt crises that will be met with market chaos and a tightening of easy credit for those who are most vulnerable to implosion.
With Puerto Rico also timed for a major default that will burden the United States, Mexico is ready to crash, and bracing for impact. Its biggest construction firm, which has been dependent upon government contracts that are now drying up, is facing default on a $31 million interest bill.
And so it begins…
In August, the bonds of Mexico’s biggest construction company, ICA, had the dubious honor of being the worst performing corporate bonds across all emerging markets. At a time when emerging economies are slowing down and the total debt exposure of EM corporations has never been higher, this was no mean feat. […]
Yesterday the company’s shares plummeted 22% on news that it would use a 30-day grace period to make a $31 million interest payment that was due this week. Today its shares, which have lost more than 75% of their value since January, fell a further 8% to 3.76 pesos, their lowest point in 21 years.
To make matters worse, the builder recently hired corporate restructuring specialist Rothschild & Co. as financial adviser, fuelling speculation that it will soon seek debt relief.
If ICA does fail to pay, it would be Mexico’s biggest bond default since the tumultuous days of the Tequila Crisis 20 years ago.
The revenue reported by the company, which depends on the government for a majority of its contracts, has sharply declined this year amidst infrastructure spending cutbacks, while the weaker peso has exacerbated the company’s leverage ratios.
As WOLF STREET previously reported (here and here), many Mexican corporations are acutely vulnerable to a strengthening dollar and rising U.S. interest rates. The sudden rise in central bank-engendered liquidity after the outbreak of the Global Financial Crisis enabled Mexico’s biggest companies to borrow from the international markets in much larger amounts and for much longer periods than at any other time in history. And the slide of the peso against the dollar has significantly increased the amount of leverage at some companies.
As the article suggests, a sluggish Mexican economy has made this company all-too-vulnerable to market failure. The dead weight of its collapse is liable to do some damage across much of the global economic landscape. The real danger is that enough incidents could set off a domino of debt bomb explosions that risk taking the whole thing with it in a brilliant fiery scene of destruction.
Goldman Sachs, so often at heart of these financial matters, recently proclaimed that we are in the third wave of the financial crisis that reaches back to before 2008 and includes other major shocks to the global economy. According to Goldman:
This wave is characterised by rock-bottom commodities prices… This triple whammy has its roots in the response to the first two waves of crisis — the banking collapse and European sovereign-debt crisis — and it is all part of the so-called debt supercycle of the past few decades.
Central banks all rushed to lower interest rates in response to the first two debt-fueled crises, encouraging investors to lend in emerging markets such as China for a decent return.
Now that interest rates are looking as if they might go up, lenders are heading for the exits and investors are pulling out of commodities, which are closely linked to the fate of the emerging economies.
And that is exactly what is going on today.
Energy and commodity prices are bottoming out, and people are stressing over the shortfalls in revenue. Weak economic systems and promises under socialism and welfare systems are making the balance sheets impossible to rectify. As lenders are demanding repayment, third world nations are under extra pressure due to a “strong” dollar that costs more to repay.
Wolf Street explains:
The Bank of International Settlements notes that the external debt in Mexico is the fourth highest of 17 emerging economies. The three economies ahead of Mexico are Chile, Malaysia and Peru. So serious is the problem that the Bank of Mexico just released a carefully worded alert on the potential dangers of excessive dollar-denominated corporate debt.
[…] Companies that have sharply increased their foreign currency-denominated debt are meanwhile advised to pay close attention to the risks they face, especially if most of their revenues are denominated in pesos.
In the case of ICA, almost all of the company’s contracts are denominated in pesos, while $1.35 billion of its debt is denominated in dollars. That’s the debt it’s now struggling to pay.
This explosion of dollar-denominated debt was not just the result of the strengthening dollar; many companies were also desperate to take advantage of exceptionally low interest rates by applying for more debt with favorable conditions. In a perversely ironic twist, out of fear that the Fed may be about to take away the ZIRP punch bowl, some of Mexico’s biggest corporations embarked on one last dollar-borrowing binge.
Seeing as how these debt bombs cannot be localized and contained, and that they are set to go off across the planet, this very possibly could be the beginning of some major impacts in global finance.
Everything is vulnerable, particularly for those depending upon income and services from a failing system. For investors, all that is leveraged, collateralized and sold into derivatives is in danger of catching flame, too. The massive amount of true global debt – when unfulfilled obligations such as pensions that cannot be paid for are taken into account – is absolutely impossible to fix through conventional thinking.
There will be many people left holding the bag, until or unless the debts are wiped clean and the system sees a reset.