Tag Archives: Junk bonds

David Stockman on the Return of Negative Yields… And What Comes Next

When you’re losing money after inflation with the highest yields available in the bond market—junk bond yields—you know the bond market is seriously distorted by central banks. From David Stockman at internationalman.com:

Negative Yields

Among all the financial market distortions and misallocations that result from the Fed’s money-pumping policies, we are hard pressed to think of something stupider and more counterproductive than negative real yields on junk bonds.

The historic yield spread over inflation of riskiest US company securities has ranged between 500 and 1,000 basis points (5–10%) or more. And for the good reason that in combination, inflation and defaults always eat deeply into the coupons so as to remind investors why it is called “junk.”

As it happened, the junk bond yield on the eve of the dotcom crash in the spring of 2000 was 12.48%, reflecting an 875 basis point spread over the CPI of 3.73%.

By the eve of the Great Recession in November 2007, the junk yield had fallen to 9.15% but that still represented a healthy spread of 478 basis points over the CPI, which had increased to 4.37% during the prior 12 months.

But those spreads self-evidently were not enough when the economy plunged into the tank during 2008–2009.

The reason the spread went nearly parabolic during the Great Recession is that the price of junk bonds collapsed by 26% as investors and speculators dumped them in the face of soaring losses and issuer bankruptcies that topped all previous cyclical highs (dotted line).

Needless to say, the Fed was not about to let Mr. Market have its way, nor honest price discovery to win out in the bond pits.

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Record Numbers Of Companies Drown In Debt To Pay Dividends To Their Private Equity Owners, by Tyler Durden

One day many of the practices described in this article will be illegal. From Tyler Durden at zerohedge.com:

One week ago we used Bloomberg data to report that in the latest Fed-fuelled bubble to sweep the market, now with Powell buying corporate bonds and ETFs, private equity firms were instructing their junk-rated portfolio companies to get even deeper in debt and issue secured loans, using the proceeds to pay dividends to owners: the same private equity companies. Specifically, we focused on five deals marketed at the start of the month to fund shareholder dividends, which accounting for half of the week’s volume, and the most in a week since 2017, according to Bloomberg.

Now, a little over a week late, the FT is also looking at these dividend recap deals which have become all the rage in the loan market in recent weeks, among other reasons because they are “ringing alarm bells since they come on top of already high leverage and weak investor protections and against a backdrop of economic uncertainty.”

Having updated our calculation, the FT finds that in September a quarter (24% to be exact) of all new money raised in the US loan market has been used to fund dividends to private equity owners, up from an average of less than 4% over the past two years: that would be the highest proportion since the beginning of 2015, according to S&P Global Market Intelligence.

As we wrote a little over a week ago, while the loan market — where PE firms fund the companies they own by selling secured first, second, third and so on lien debt — had until recently not seen the same volume of issuance as other parts of the financial markets. That changed after the Fed stepped into the corporate bond market sending yields crashing to record lows, and forcing US investors into the last corner of the fixed income world to still offer some modest yields: leveraged loans. And since this is the domain of PE firms which desperately need to extract as much cash as they can from their melting ice cubes (another names for single-B and lower rated portfolio companies which will likely all be broke in the next 3-5 years), everyone is rushing to market with dividend recaps to pay as much to their equity sponsor as they can before the window is shut again.

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The Global Debt Bubble Enters Its Blow-Off Stage, by John Rubino

When the bubble pops, the losses are going to be staggering, far larger than a global equity crash (the world’s bond markets dwarf the world’s stock markets). From John Rubino at dollarcollapse.com:

People have been talking about a “debt bubble” for some years now. They’ve been right, of course, based on the combination of surging borrowing and plunging rates.

Though July, China’s total debt rose by $2 trillion, a year-over-year increase of 26%. And this month the Chinese government cut bank reserve requirements in an attempt to further rev up lending.

In Japan, the junk bond market is being constrained by banks so desperate for yield that they’re lending directly to companies previously considered too risky. See Japan Junk Bond Market Hopes Crushed by Banks Hungry to Lend.

A recent week of corporate bond issuance was “the biggest weekly volume to hit global markets on record,” according to Dealogic. US investment-grade companies raised $72 billion across 45 deals, equaling the total issued in all of August.

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Here’s Where the Next Crisis Starts, by James Rickards

Junk bonds are certainly a plausible candidate for where the next financial crisis begins. From James Rickards at dailyreckoning.com:

The case for a pending financial collapse is well grounded. Financial crises occur on a regular basis including 1987, 1994, 1998, 2000, 2007-08. That averages out to about once every five years for the past thirty years. There has not been a financial crisis for ten years so the world is overdue. It’s also the case that each crisis is bigger than the one before and requires more intervention by the central banks.

The reason has to do with the system scale. In complex dynamic systems such as capital markets, risk is an exponential function of system scale. Increasing market scale correlates with exponentially larger market collapses.

This means a market panic far larger than the Panic of 2008.

Today, systemic risk is more dangerous than ever because the entire system is larger than before. Due to central bank intervention, total global debt has increased by about $150 trillion over the past 15 years. Too-big-to-fail banks are bigger than ever, have a larger percentage of the total assets of the banking system and have much larger derivatives books.

Each credit and liquidity crisis starts out differently and ends up the same. Each crisis begins with distress in a particular overborrowed sector and then spreads from sector to sector until the whole world is screaming, “I want my money back!”

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The Dirty Dozen Sectors of Global Debt, by Jonathan Rochford

This is a very good survey of the diciest corners of the international credit markets, the ones most likely to start the global credit crisis that nobody will see coming. From Jonathan Rochford at narrowroadcapital.com:

When considering where the global credit cycle is at, it’s often easy to form a view based on a handful of recent articles, statistics and anecdotes. The most memorable of these tend to be either very positive or negative otherwise they wouldn’t be published or would be quickly forgotten. A better way to assess where the global credit cycle is at is to look for pockets of dodgy debt. If these pockets are few, credit is early in the cycle with good returns likely to lie ahead. If these pockets are numerous, that’s a clear indication that credit is late cycle. This article is a run through of sectors where I’m seeing lax credit standards and increasing risk levels, where the proverbial frog is well on the way to being boiled alive.

Global High Yield Debt

Last month I detailed how the US high yield debt market is larger and riskier than it was before the financial crisis. The same problematic characteristics, increasing leverage ratios and a high proportion of covenant lite debt, also apply to European and Asian high yield debt. Even in Australia, where lenders typically hold the whip hand over borrowers, covenants are slipping in leveraged loans. The nascent Australian high yield bond market includes quite a few turnaround stories where starting interest coverage ratios are close to or below 1.00.

Defined Benefit Plans and Entitlement Claims

For many governments, deficits in defined benefit plans and entitlement claims exceed their explicit debt obligations. The chart below from the seminal Citi GPS report uses somewhat dated statistics, but makes it easy to see that the liabilities accrued for promises to citizens outweigh the explicit debt across almost all of Europe.

In the US, S&P 500 companies are close to $400 billion underfunded on their pension plans. This doesn’t seem enormous compared to their annual earnings of just under $1 trillion, but the deficits aren’t evenly spread with older companies such as GE, Lockheed Martin, Boeing and GM carrying disproportionate burdens.

Latest forecasts have US Medicare on track to be insolvent in 2026. At the State government level Illinois ($236 billon) and New Jersey ($232 billion) both have enormous liabilities, mostly pension and healthcare obligations. If you want to understand how pension and entitlement liabilities have grown so large, my 2017 article on the Dallas Police and Fire Pension fiasco and John Mauldin’s recent article “the Pension Train has no Seatbelts” are both worth your time.

To continue reading: The Dirty Dozen Sectors of Global Debt

12 Indications That The Next Major Global Economic Crisis Could Be Just Around The Corner, by Michael Snyder

You don’t have to look too hard to see some ominous portents for the global economy. From Michael Snyder at theeconomiccollapseblog.com:

There have not been so many trouble signs for the global economy in a very long time.  Analysts are sounding the alarm about junk bond defaults, the smart money is getting out of stocks at an astounding rate, mortgage rates are absolutely skyrocketing, and Europe is already facing a full blown financial meltdown.  Of course expectations that another global economic crisis will happen among the general population are probably at an all-time low right now, but the reality of the matter is that we are probably closer to a new one erupting than at any point since the last one in 2008.  Since the last financial crisis our long-term debt problems have just continued to grow, and there are many that believe that the next crisis will actually be far worse than what we experienced ten years ago.

So how bad are things at this moment?

The following are 12 indications that the next major global economic crisis could be just around the corner…

#1 The “smart money” is getting out of stocks at a rate that we haven’t seen since just before the financial crisis of 2008.

#2 Moody’s is warning that a “particularly large wave” of junk bond defaults is coming.  And as I have written about so many times before, junk bonds are often an early warning indicator for a major financial crisis.

#3 According to the FDIC, a closely watched category known as “assets of problem banks” more than tripled during the first quarter of 2018.  What that means is that some really big banks are now officially in “problem” territory.

#4 U.S. Treasury bonds are having the worst start to a year since the Great Depression.

#5 Mortgage interest rates just hit a 7 year high, and they have been rising at the fastest pace in nearly 50 years.  This is going to be absolutely crippling for the real estate and housing industries.

#6 Retail industry debt defaults have hit a record high in 2018.

To continue reading: 12 Indications That The Next Major Global Economic Crisis Could Be Just Around The Corner

It’s Really Crazy What This ECB Has Wrought, by Wolf Richter

Europe is a borrower’s paradise and a saver’s hell. From Wolf Richter at wolfstreet.com:

In the land of NIRP refugees and “Reverse Yankees,” who will get crushed?

At the end of the week, something special happened, something totally absurd but part of the new normal: the average yield of euro-denominated junk bonds – the riskiest, non-investment-grade corporate bonds – dropped to the lowest level ever: 2.77%.

April 26 had marked another propitious date in the annals of the ECB’s negative yield absurdity: the average euro-denominated junk bond yield had dropped below 3% for the first time ever.

By comparison, what is considered the most liquid and save debt, the 10-year US Treasury, carries a yield of 2.33%; the 30-year Treasury yield hovers at 3%.

This chart of the BofA Merrill Lynch Euro High Yield Index (data via FRED, St. Louis Fed), shows just how crazy this has gotten in the Eurozone:

It’s not like there’s deflation in the Eurozone, despite rampant scaremongering about it. The official inflation rate in April was 1.9% for the 12-month period. As this chart shows, it’s not likely to go away any time soon (via Trading Economics):

In other words, the average “real” junk bond yield (after inflation) according to the above two indices is now 0.87%. That’s the return bond-buyers get as compensation for handing their money for years to come to non-investment grade corporations – as per an average of the ratings by Moody’s, S&P, and Fitch – with an appreciable risks of default looming on the horizon.

Issuing junk bonds in euros is not just the prerogative of European companies. It includes issuance of junk-rated US companies that seek out this cheap money. “Reverse Yankees,” as these bonds are called, have become a large factor in euro-bond issuance.

And investors that accept a “real” compensation of only 0.87% per year to deal with these risks – have they gone nuts? You bet.

To continue reading: It’s Really Crazy What This ECB Has Wrought

Why this Spike Will Perforate Yield Chasers, by Wolf Richter

Jim Grant once said that reaching for yield during a market configuration of bond yields and risk remarkably like today’s (except it was slightly less risky) was like reaching for a razor blade in the dark. From Wolf Richter at wolfstreet.com:

Record moneys suddenly pile into the material of debt crises.

The Institute of International Finance opined last week that “the ‘low for long’ interest rate outlook now looks more like ‘low forever’ – an outcome that has unleashed a powerful renewed search for yield.”

They’re all doing it.

Japanese investors, such as pension funds and insurance companies, are swarming into US Treasuries now more than ever.

According to the Ministry of Finance, for the week ended July 16, Japanese investors bought a net ¥1.718 trillion ($16.2 billion) of foreign “long-term” debt (everything except “short-term” debt). The week before, they’d bought a net ¥2.55 trillion, the highest on record. And according to the MOF, they were mostly buying US Treasuries.

For them it makes sense: the 10-year punishment yield of the Japanese Government Bond is a negative -0.22%. But the 10-year Treasury yield is still a positive 1.57%. And with the Bank of Japan being outspoken about wanting to crush the yen, the hapless Japanese have even more reason to seek refuge in US paper. We can’t blame them.

Europeans are doing the same thing, buying US Treasuries, but also US corporate bonds, and even US junk bonds.

“NIRP refugees” we’ve come to call them. They’re trying to escape their central bank’s iron-fisted financial repression where bond buyers are guaranteed to lose money if they hold bonds to maturity, which many institutional investors need to do – such as pension funds and insurance companies. It impacts everyone since they’re managing the money of regular folks.

Over $12 trillion of bonds are trading with punishment yields these days. So investors are chasing positive yield where they can, thereby transferring the effects of central-bank policies from their bailiwicks to the US, and in turn pushing down yields in the US.

But where do American investors go to chase yield, now that Treasury yields are disappearing before their very eyes?

Junk bonds. And they have soared, and yields have plunged over the past few months.

And dividend stocks. Even classic bond buyers are switching to stocks that pay a dividend, to get a little extra yield. But companies can eliminate dividends in no time, and the yield goes to zero while the stock dives. A bond would be in default if the issuer were to stop paying the coupon. By that time, bankruptcy lawyers are circling. But cutting a dividend is routinely done during market downturns, and yield investors who switched from bonds to dividend stocks have a rude awakening.

And now everyone has rediscovered another source of yield. The Financial Times, about what happened over the past two weeks:

Investors are piling into emerging market bond funds at the fastest pace on record as pension funds, sovereign wealth funds, and other big institutions follow more seasoned specialists into riskier asset classes in search of yield.

“This is capitulation,” Sergio Trigo Paz, head of EM fixed income portfolio management at BlackRock, told the Financial Times. “The big, big investors are starting to move.”

More comprehensive data from the Institute of International Finance show that last week, cross-border flows to EM stocks and bonds hit their highest level since the US Federal Reserve shocked markets by pulling back from a rise in interest rates in September 2013.

To continue reading: Why this Spike Will Perforate Yield Chasers

There’s a $1 trillion bubble that’s ready to burst, by Bob Bryan

What really gets the ball rolling on debt contraction and deflation is when the junkiest credits start going toes up. From bob Bryan from businessinsider.com:

There’s a huge bubble at the bottom of the bond market, and when it pops it could put $1 trillion at risk.

“In short, we believe there is a corporate credit bubble in speculative grade credit. And the structural downside risks for high yield bonds and loans are material, with non-negligible downside risks to growth,” UBS’ Matthew Mish wrote in a note to clients.

Mish argued that below the surface of corporate bonds, all the way down at the bottom-most levels of junk, there is a bubble forming.

“We believe roughly 40% of all issuers are of the lowest quality, and roughly $1tn which will end up ‘distressed debt’ in this cycle,” Mish wrote. “Much of the debt was bought to pick-up yield linearly, but the default risk is exponential.”

So how did we get here? Mish believes there are three circumstances that have inflated the bubble:

  1. Central bank support allowed zombie companies to stay afloat, carrying over larger debt loads and then adding even more of it on top of unproductive firms.
  2. Low-yields in Treasuries forced pension funds and other investors with nominal return targets toward more speculative debt in order to meet those goals. “Investors were herded into lower-quality credit risk for a yield pick-up of a couple hundred basis points,” Mish wrote.
  3. The heightened demand from these funds for high yields created ease of access for speculative-grade issuers to find a market for their debt. “The proportion of triple C rated issuers in its speculative grade universe (bonds and loans) reached a new record to start 2016; 1,356 out of 3,181 issuers or about 42% of the total,” Mish said.

The next question, Mish wrote, is where do we go now?

On the bull side, the recent widening of credit spreads is simply a case of the debt market “deteriorating incrementally, and from a relatively healthy position.”

Then there’s the bear side that the bubble has formed and widening spreads and defaults, especially in higher yields, are sign of a coming disaster wrote Mish.

In his mind, Mish is heavily leaning toward the bears. For one thing, bubbles such as the one in high-yield credit have to burst eventually, so at the very least the clock is ticking.

Additionally, according to Mish, the current state of the credit market is looking like time is close to up before it bursts.

“Commodity-related stress will push default rates up towards 5-6%, without assuming much increase in non-commodity defaults,” said the note.

“But the broader speculative grade universe is highly leveraged – particularly the lower quality segment (many single Bs, nearly all triple Cs), which, by definition, leaves them more exposed to peaking profit margins, rising interest costs and a slowdown in US growth,” Mish added in the note.

This last point is overlooked, Mish said, since most analysts look at just the leverage of the market aggregate. However, 10% of the companies in the S&P 500 hold 70% of the cash, so the lower-quality names where the bubble has formed are worse off than it looks.

To continue reading: There’s a $1 trillion bubble that’s ready to burst

OK, I Get it, this Junk-Bond Miracle-Rally Is Doomed, by Wolf Richter

With modern day central banking and its interest rate suppression and “puts” under equity markets, those markets are officially the last to get the joke. Other markets began recognizing the looming debt contraction and deflation back in the end of 2014, when commodities crashed. That crash has worked its way up real economy supply chains—intermediate and final goods—transportation, manufacturing, and retailing, finally hitting holdouts like autos and restaurants. On the finance side, credit spreads have been widening relentlessly. What to make of a recent respite? From Wolf Richter at wolfstreet.com:

And since stocks follow junk bonds….

Junk bonds started to decline in June 2014, and earlier this year threatened to implode. Contagion was spreading from the collapsing energy sector to the brick-and-mortar retail sector, telecom (Sprint), the media (iHeartRadio), and other sectors. It was really ugly out there.

As junk bond prices got beaten down, yields soared. The average yield of BB-rated bonds,the top end of the junk-bond scale, according to the BofA Merrill Lynch index, went from 4.2% to 7.07% between June 2014 and February 11, 2016. For CCC-and-lower-rated junk bonds – the bottom end of the scale, deemed to be within uncomfortable proximity to default – the yield BofA Merrill Lynch index shot up from around 8% to 21.5% between June 2014 and February 12, 2016.

But then the Fed heard the screaming from Wall Street about the chaos in the markets, with junk bonds losing their grip and large swaths of stocks careening deeper into a bear market. Incapable of any independence whatsoever, it brushed rate hikes off the table and changed its verbiage. What ensued was a marvelous rally all around, particularly in bonds.

In two months, the beaten-down junk-bond ETF (HYG) soared 9.1%, though it remains 14% below its recent peaks in April 2013 and June 2014. The yield of the BofA Merrill Lynch index for BB-rated bonds dropped 171 basis points to 5.36%. And at the low end of the scale, all heck broke loose. As these beaten-down bond prices jumped, the yield of the BofA Merril Lynch index for CCC-and-lower-rated bonds dropped 369 basis points to 17.8%. A huge two-month rally (circled in red):

Default or bankruptcy, no problem. It’s been that kind of rally.

So far this year, there have been 37 corporate defaults by S&P-rated issuers in the US, the highest year-to-date since 2009 when there were 53. This wave of defaults is expected to become a tsunami, not because the Fed is going to raise rates, which it might not, but because over-indebted money-losing companies with declining revenues have been pushing their luck, and investors have finally woken up.

To continue reading: OK, I Get it, this Junk-Bond Miracle-Rally Is Doomed