Junk Bond Borrowing Binge
A Borrowing Binge Reaches the Riskiest Companies.
Companies such as hospital operator Community Health Systems Inc. and newspaper publisher Gannett Co. have issued a record $139 billion of bonds and loans with below- investment-grade ratings from the start of the year through Feb. 10, according to LCD, a unit of S&P Global Market Intelligence. More than $13 billion of that debt had ratings triple-C or lower—the riskiest tier save for outright default—about twice the previous record pace.
Despite the onslaught of new bonds, riskier companies can now borrow at interest rates once reserved for the safest type of debt.
The most striking aspect of the current lending boom is its timing. Typically, it can take years after recessions for the market to reach its present level of exuberance, analysts said. In this case, it has taken less than 12 months and has arrived just as economic data have revealed a winter slowdown in the recovery.
In recent weeks, three businesses have financed dividends to private shareholders by issuing PIK toggle notes—bonds that give the issuer flexibility to pay interest in additional bonds rather than cash. Such deals are hallmarks of hot credit markets, rising to prominence in the years leading up to the 2008-2009 financial crisis.
“The way the market is viewing this right now is basically saying, if all these triple-Cs can access funding, they’re not going to default,” said Oleg Melentyev, head of U.S. high-yield strategy at BofA Global Research.
The problem, he said, is investors are “hoping that this argument will work longer than it probably will.”
Bond Ratings
Investors are plowing into garbage just above default.
Q: Why?
A: Fed Triggered Mania
There Are No Hawks on the Fed, Only Ostriches
On January 15, I commented There Are No Hawks on the Fed, Only Ostriches
Not to worry, “We’ll let the world know,” when we spot inflation says Powell who cannot see the big pink elephant standing right on the Fed’s table.
The immense asset bubbles in the stock market, housing market, and bond market, provide ample evidence of inflation.
Instead, the Fed and most economists view the CPI, a fatally flawed measure, as representative of inflation.
The result of their head in the sand approach is three consecutive asset bubbles in 20 years, with increasing amplitude.
Fed’s New Facility Will Buy Junk Bonds With 7-1 Leverage
On June 15, 2020 I noted Fed’s New Facility Will Buy Junk Bonds With 7-1 Leverage
Moral Hazard
With highly questionable legality on top of a 100% certain moral hazard, here are the details of the Fed’s new Secondary Market Corporate Credit Facility
Credit Facility Terms
- The issuer was rated at least BBB-/Baa3 as of March 22, 2020, by a major nationally recognized statistical rating organization (“NRSRO”). If rated by multiple major NRSROs, the issuer must be rated at least BBB-/Baa3 by two or more NRSROs as of March 22, 2020.
- An issuer that was rated at least BBB-/Baa3 as of March 22, 2020, but was subsequently downgraded, must be rated at least BB-/Ba3 as of the date on which the Facility makes a purchase. If rated by multiple major NRSROs, such an issuer must be rated at least BB-/Ba3 by two or more NRSROs at the time the Facility makes a purchase.
- The issuer has not received specific support pursuant to the CARES Act or any subsequent federal legislation and must satisfy the conflicts of interest requirements of section 4019 of the CARES Act.
Leverage
- The Facility will leverage the Treasury equity at 10 to 1 when acquiring corporate bonds of issuers that are investment grade at the time of purchase.
- The Facility will leverage its equity at 7 to 1 when acquiring corporate bonds of issuers that are rated below investment grade at the time of purchase and in a range between 3 to 1 and 7 to 1, depending on risk, when acquiring any other type of eligible asset.
Not Remotely Legal
Not only is the facility illegal, it’s a moral hazard asset prices support system that keeps zombie corporations alive.
Mish
In my career, my defined benefit pension went from 105 percent funded to 51 percent funded. A combination of politicians who are cash basis instead of accrual basis, and a Federal Reserve that doesn’t understand that gold is what kept them from being slaves of Congress.
Businesses that are otherwise profitable can have drop down, immediately dead heart attacks from cash flow issues. For the UK one of the recessions was worsened because of chaining of delayed (because of cash flow) supplier payments causing cascading bankruptcies from cash flow issues.
The fed only has a shotgun, a broad brush, so the anticipation must be a funding crisis. After all who would want to hold corporate debt during a pandemic, far better to keep the powder dry for fire sales after. Fed pressing pause on “creative destruction”
This is all just a bailout of pension funds and other instruments. Everyone knows the this now and we just pretend. There is a lot of pretending going on but how else can a central bank take care of 7B+ people. Corruption is why we win.
The 10 yr US bond sold off hard today. This is feeling like a yield breakout with the 50 and 200 day moving averages trending UP. Yields have not surpassed the pre-COVID rates, but most of the lending has occurred below today’s rates, so there is no refinancing those stimulus loans through the market.
What could possibly go wrong?
Oh wow!
When you thought things couldn’t become more ridiculous.
Not just corporate debt – lots of other assets as well. Interesting that gold has massively underperformed in comparison…
Lots of wealth floating around looking for a home while most stand by and watch. Inequality has a perverse effect on markets.
My POV, for 4 decades gov has implemented tax, deregulatory, foreign trade policies that have only benefitted the top income earners, shareholders, C-suites.
The Fed has had to accommodate the resulting household & government debt with increasingly lower rates.
My answer, regulate market (and housing) speculation, or modify rates on market activity/margin, increase income tax for top brackets, do something about household wages, and only then can the Fed tighten.
There are babies in the bath water folks, a lot of ’em.
Junk yields will keep going down. Once the FED starts buying an asset class, the yield approaches 0. This is what happens when you have an entity buying securities that isn’t trying to make a profit.
Still a better investment than tesla. A company that has never figured out how to sell cars for more than they cost to make and has a mkt cap > the next 6 car companies combined. tesla is going to be the poster child for the current bubble.
Watch HYG, when it breaks down it is a signal.
With care, sometime, there will be a chance to lock in high rates even allowing for defaults.
Great opportunity will arrive if you have the cash available.
Mish, since the Secondary Market Corporate Credit Facility came into being in June 2020 as a result of the pandemic do you expect it to become permanent or quasi-permanent even when conditions normalize?
Once illegal powers are taken by the Fed I know of no instances when they stop
It reminds me of September 21, 2008 when Goldman Sachs and Morgan Stanley were accorded a banking licence by the FED. It made me so angry that I left the business. The markets then became truly and openly rigged.
Here’s a visualization of all the extracted gold in the world and which countries own it
I see Italy is well-endowed in gold. That will be useful if/when Italy leaves the Euro.
2021 We party like never before. We now have canibus and beer.
insatiable demand for risky bond and Yellen about to flood the maket with cash drivi rates even lower. not only is it confusing but it looks like a recipe for disaster
https://finance.yahoo.com/news/yellen-shift-vast-treasury-cash-100000816.html#:~:text=Yellen%20Shift%20on%20Vast%20Treasury%20Cash%20Pile%20Poses%20Problem%20for%20Powell,-article&text=The%20move%2C%20which%20aims%20to,grip%20over%20money%20market%20rates.
Create inflation so the poor becomes poorer –> democrats now have a platform for election by promising to raise minimum wage and benefits –> democrats are elected, minimum wage and benefits raised –> cycle.
More “Party on” – until we can’t…
Too much cash plus a dearth of good projects that give a decent return on cash flow equals cash going into quoted assets that go up in price because of excess cash that is there because of a dearth of projects that give a decent return on cash flow.