By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Wolf Street
The year 2015 has just started, and already there have been two junk-bond casualties: the first on Thursday, and the second one yesterday. They weren’t energy companies. Energy companies don’t even try anymore. They’ve been locked out. Both deals had to be scuttled because, even at the high yields they offered, there were suddenly no buyers. 2014 had been a harbinger: 17 junk-bond deals for $5.8 billion in total were shelved, most of them during the last four months.
Ever since the Fed unleashed its waves of QE, institutional investors, driven to near insanity by the relentless interest rate repression, have been chasing yields ever lower in a desperate effort to get some kind of return. In the process, junk bonds and leveraged loans boomed and spiraled to such heights that the Fed – which is never able to see any bubbles – and other bank regulators began fretting over a year ago about the risks they posed to “financial stability.” And in December, it was the Treasury that hit the alarm button about leveraged loans [read… Treasury Warns Congress (and Investors): This Financial Creature Could Sink the System].
Now QE Infinity is gone, interest-rate hikes are vaguely shaping up on the horizon, and institutional investors – bond mutual funds, for example – are getting second thoughts.
Junk bond issuance, at $13.4 billion so far this year, is down 32% from the same period in 2014, according to S&P Capital IQ/LCD’s HighYieldBond.com. Lower-rated companies are “forced to pay-up significantly,” explained LCD’s Joy Ferguson. And some of them, like the Presidio Holdings deal today, are having trouble finding any buyers – despite offering a yield of 11% or higher.
Investors are bailing out of junk-bond funds. In the latest week, $241.2 million were withdrawn from high-yield mutual funds and ETFs. The week before had been an exception, with an inflow of $897.5 million, after eight weeks in a row of relentless net outflows. And investors have been abandoning leveraged-loan funds for 28 weeks in a row, yanking out $738 million in the latest week alone.
Below-investment-grade companies are feeling the consequences.
So, Koppers Holdings announced on January 14 that it would issue $400 million in junk bonds. The company makes carbon compounds and treated wood products for utilities, railroads, the construction industry, and the like. With revenues in Q3 of $440 million, it booked a net loss of $2.7 million. Its shares (KOP), which peaked in November 2013 at $50, are now at $20.
It would use $300 million of the proceeds from these senior notes to pay off older senior notes due in 2019 and use the remainder for other purposes. After the announcement, S&P downgraded the company one notch to B+, on the expectations that EBITDA and credit measures would be weakened. Moody’s, which rates the company Ba3, lowered its outlook to negative from stable, blaming lower oil prices and “unfavorable end market conditions.”
And investors lost their appetite. So on Thursday, Koppers had to scuttle its junk bond deal. The first junk-bond casualty this year. The second one fell today.
On December 1, 2014, private equity firm American Securities announced that it would sell its portfolio company, Presidio, a technology consulting company with 6,000 clients and 2,200 employees, to another PE firm, Apollo Global Management. To pull off the deal in good PE form, Presidio would have to be loaded up with a lot more debt.
Presidio had already been loaded up with debt, most recently in March 2014, when it borrowed $650 million via a leveraged loan due March 2017. The money was then used to pay back older debts and hand American Securities a special dividend of $265 million, which is how PE firms strip-mine pure moolah out of their portfolio companies.
And for Apollo to buy Presidio, a lot more debt would be piled on top of it all. There would be a $600-million covenant-lite leveraged loan. It took some doing. But on Monday, the loan (rated B/B1) finally cleared, after the terms had been substantially sweetened since initial talk in early January. Investor-friendly provisions were added, and the yield to maturity was raised to about 7%, up from 6%. The transaction also includes a revolving credit line of $50 million and an accounts receivable securitization facility of $200 million.
The same day, Presidio was supposed to issue $400 million in junk bonds. They would be rated CCC+/Caa1, so neck-deep into junk territory. Initially, the yield had been pegged at around 9%, but potential buyers yawned. So sweeteners were added, and the yield was raised to 11%. Today, and despite all the added goodies, HighYieldBond.com reported that the deal was scuttled due to “insufficient demand at price talk.”
Government bonds in many developed economies are now sporting absurdly low yields – such as “negative” yields – as central banks push interest-rate repression to extremes. And other areas of the biggest credit bubble the world has ever seen are still inflating as well. But in the area of junk bonds, particularly at the lower-rated end, a sense of inconvenient reality has pricked the bubble. Investors have opened their eyes, and they’re asking questions, and they’re walking away from toxic deals that would have flown off the shelf not long ago.
Presidio and Koppers aren’t even directly involved in the oil-and-gas sector where junk bond issuance has collapsed, and where companies are not even attempting to issue junk bonds anymore. They’ve been locked out. They’re trying to make do with what they have. But time and money are running out for them. Read… Junk Bonds and Fracking at Low Oil & Gas Prices: Wave of Defaults, “Outright Liquidations” Next
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So the question is, where are investors dumping their money? Or are investors simply battening down the hatches and preparing to ride out the storm in US Treasuries?
Money running to US T-bags…all day…every day
“ride out the storm”…….. ashore in cash – which has its own rewards – sooner or later liquidity is an opportunity!
“…ride out the storm in US Treasuries?”
Highly unlikely. Prices of treasuries have to increase in order to drive the interest rate down. This gives capital gains instead of interest income. With the interest rate as low as it can possibly go, the prices of treasuries will be as high as they can possibly go. Therefore very little capital gains remain in treasuries, the money invested in such will just lie there with little interest income to show. Also, to remain in this vehicle is to risk price declines when interest rates eventually return to historical norms.
Given the historically high average P/E ratios in the stock market these stock securities reflect little growth opportunity. And with the economy doing poorly, dividend income will be rather elusive. So what’s left???
Jeff Gundlach expects interest rates to go lower.
So? Why do you choose Gundlach out of the herd of investment adviser’s? I’m not familiar enough with his investing philosophy to make any comment. However, I’ve been broken of the habit of following any particular adviser a long time ago. And how much is remaining in bonds for profit? This with the Fed hinting at raising rates as soon as it can. Bulls make money, bears make money. Pigs never make money. Still, on the other hand, bonds will more likely just give you a shave instead of a haircut. Lower rates will probably help keep the stock market levitated for a while longer….maybe. Consider also, that QE is a historical event. There are a lot of black swan events occurring, too. All is uncertainty. Definitely the Fed has an interest in maintaining the value of the dollar. Yet, all in all, given the complexity of investor interests, the understanding that one is dealing with non-normal distribution curves might be helpful. It’s now like the weather, normal expectations can’t be relied on. One thing we do know for certain, money is being sucked out of the economy, both here and in Europe in spite of QE here and there. What next black swan event will push us into frank deflation isn’t known. What happens then, while all markets are relatively inflated. Bonds, stocks and commodity’s? Paper assets.
so interest rates increase (hypothetically)
discounts from face price cause bond value to fall
stock market yield is what? plunge protection?
what great options for the Fed at the zero bound?
the helicopters are all delivering AK 47 to ISIS or something like that.
“QE infinity gone”? Hardly, the Fed’s balance sheet hit an alltime high in December. They made it clear they wouldn’t shrink it before the end of the decade at earliest, so everything that matures on their books goes straight back to the orgy of monetization.
Though the MMT’ers assure me that unlimited confetti oops I mean money creation will not have any adverse impacts LOL.
“..Fed’s balance sheet…”
Which largely goes nowhere. It’s the low interest rates that are driving the stock market and paper asset inflation. Meanwhile, the banks are buying real assets. Commodities, businesses, infrastructure. If you were a contrarian investor, your job would be to anticipate where the banks are going next so you could get ahead of them or at least recognize what they are moving into. The banks are doing what they have always done. I don’t get why people expect a leopard to change it’s spots. By the time the general public begins investing, the banks are moving on. Buy low, sell high. Charge tolls.
Can someone try to explain to me why no one mentions the obvious, that after thirty five years of suppressing wages to increase profits and therefore to increase financial capital, that we now have way too much financial capital, orders of magnitude more than is needed or can ever be used for real investment in businesses and their production facilities, and we have too little money going to demand which is largely from wages.
That for years we have papered over the relative loss in wages and demand by going from one to two incomes in a family and by dramatically increasing personal debt. But that these measures can only carry us so far and that we are now at their limits.
And this excess financial capital chasing returns is what is building all of these asset bubbles, not loose monetary policy or some unknown sea change in the working of the economy.
That the main reason that we have ever increasing income inequality is because thirty five years ago we instituted policies that intentionally increased income inequality.