Corporate debt, already at record-high levels at the start of the year, will erode hopes of a quick recovery, as the economy is already seeing a wave of bankruptcies and loan defaults as businesses grapple with widespread closures on one side and tightened credit on the other, according to the Wall Street Journal. Already, corporations have failed to meet some $64.1 billion in debt obligations over the past year, and the figures are expected to grow even more dire as time goes on, possibly topping the $340 billion in debt that met the same fate in the last financial crisis. The Journal said that professionals specializing in distressed companies have already seen an uptick in restructurings and defaults.

Banks have also been sounding the alarm on this issue, according to Bloomberg. Germany's Deutsche Bank is only the latest financial institution to warn that we will likely see a higher number of credit defaults as the pandemic works its way through the economy, and has set aside 500 million euros in anticipation of this possibility. Neiman Marcus stands as one example, as Reuters recently reported that the retailer was working on bankruptcy plans that would let it get out from under at least some of its massive debt.

Moody's has been anticipating trouble in this sector for some time now: At the end of March, it had estimated that speculative-grade debt (also known as junk) would reach a default rate of 6.8 percent over the next year in the best case scenario, 16.1 percent in conditions similar to those in the last financial crisis, and 20.8 percent in the event it's even worse. The company revised its projections in a report last week , saying that while the number of defaults in March was lower than expected, this is merely the "calm before the storm," as the default rate is expected to reach 14.4 percent by next year. 

Such defaults are already starting to affect the $600 billion market for collateralized loan obligations (CLOs), asset-backed securities based on business loans, many of them risky. S&P is reporting that these assets—held mostly by banks, insurance companies, mutual funds, pension funds and private equity firms—have seen serious degradation in just two months in terms of their credit quality: Since early March, the average CLO has dropped from B+ to B ratings overall, and the share of CCC-rated bonds within them has grown from 4 to 12 percent. Basically, the business loans that undergird the value of these CLOs have become increasingly likely to default.

To understand what this might mean, one might look to an S&P report from last November, before the credit crisis began. The report explored three different scenarios of escalating intensity. The worst-case scenario assumes a 4.65 percent default rate, almost quaint, given the dire predictions today. In such a world, S&P estimates that CLOs will lose an average value of 2.5 percent; however, considering that projected default rates are now expected to be almost seven times that amount, losses might ultimately be a lot larger.

Another part of this "worst" case scenario is that the proportion of CCC-rated loans in CLOs will rise to 19.1 percent. This theoretically could trigger safety measures that require that loans falling below certain credit standards be ejected from the CLO and sold off somewhere else, usually at a severe loss. Since many CLOs require that loans within it be of a certain quality, a higher proportion of lower-rated loans will likely trigger a collateral quality test and require the manager to eject poorly-performing loans. While this prevents the asset from degrading the way that collateralized mortgage obligations did during the last financial crisis, the safety measure assumes companies will only be ejected a few at a time; en masse downgrades could require CLOs to purge huge portions of their assets, severely reducing their value and forcing investors to take further losses.

Despite these mounting risks, investors, hungry for profit in a low-interest rate world, have turned their attention to a new source of income: auto loans, according to the Wall Street Journal. Specifically, bonds linked to car loans in the same way that CLOs are linked to business loans and CMOs are linked to home loans. Demand for these bonds, of which $8 billion have been issued this year alone, has now outstripped supply, almost as much as the $10 billion worth issued through all of last year. Yet the Journal notes that these bonds have the same types of risk as other asset-backed securities: What if people don't pay their loans? This is apparently happening already: JPMorgan reported that debt payment extensions for auto loans rose from 1 percent in February to 7.5 percent in March, while Fitch said that its outlook on the auto-loan sector, overall, has worsened in light of the coronavirus pandemic.It would appear, though, that traders remain untroubled by this worsening.