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The Zombie Companies Are Coming

The Zombie Companies Are Coming

Easy money is a curse for capitalism.

Through the first half of August – which is normally a quiet period for the bond market in the US – a total of $56 billion in junk bonds and leveraged loans were issued by junk-rated companies, according to S&P Global. That was nearly 50% higher than the prior records for the same period in 2012 and 2016, and more than double the amount issued in the entire month of August last year.

The Fed’s announcement on March 23rd that it would start buying corporate bonds and bond ETFs set off a huge rally in the bond market, including in the junk-bond market.

The rally started before the Fed ever actually bought the first bond. And then the Fed hardly bought anything by Fed standards. Through the end of July, it bought just $12 billion in corporate bonds and bond ETFs, including a minuscule $1.1 billion in junk bond ETFs. It’s not even a rounding error on its $7-trillion mountain of assets.

But the announcement was enough to trigger the biggest junk-debt chase in the shortest amount of time the world has likely ever seen. And it kept the zombies walking, and it generated a whole new generation of zombies too.

The junk-bond ETFs the Fed dabbled in hold junk-bonds issued by companies that have been taken over by Private Equity firms in leveraged buyouts, where the acquired company itself borrows the money to pay for its own acquisition. Leveraged buyouts produced the first big wave of bankruptcies among retailers that started years before the Pandemic, and included Toys R Us, now liquidated.

The junk bond ETFs that the Fed has bought hold these types of bonds, including bonds by PetSmart, which was taken over in a leveraged buyout by private-equity firm, BC Partners.

…click on the above link to read the rest of the article…

Wait, why is The Fed buying my biggest competitors’ bonds?

Wait, why is The Fed buying my biggest competitors’ bonds?

On Cantillionaires, Sycophants and Losers

“It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning”

— Henry Ford

“The ultimate crisis will occur when the situation is so thoroughly perverted that the defenders of the status quo can no longer resurrect confidence in the system”

— Vincent LoCascio, Special Privilege: How the Monetary Elite Benefit at Your Expense

Over several previous blog incarnations I’ve been writing about a couple of core themes. When I started writing about artificially low interest rates and the bad outcomes they would produce, I didn’t even know the economic terms for some of the things I was writing about.

But I knew keeping interest rates artificially low, or even negative would act like a type of event horizon that would be impossible to normalize from. I knew keeping interest rates too low for too long would force fiduciaries and capital allocators out the risk curve in search of yield, and that the most vulnerable among us, such as senior citizens, were the least able to absorb the inevitable drawdowns that would entail.

I also realized early on that hot money and credit expansion would spur an explosion of money losing unicorns, who would suck up all the oxygen in all the markets cannibalizing entire markets at a loss in order to get that Series E or F up-round. That one became apparent to me when I started seeing billboards for one of my largest competitors every 1/4 mile across the entire city of Toronto on my daily commute, and every other place else I ever travelled to in North America. I knew that they were losing about $300,000,000 a year at the time. They also had some pretty kick-ass Super Bowl commercials.

I only learned about Richard Cantillon and his early economic treatise a couple years ago and since then I’ve never been able to shut up about The Cantillon Effect, which is what all this describes and what I think is the single most divisive, corrupting and toxic dynamic shaping our world today.

Max Keiser recently coined the phrase “Cantillionaires”, and that’s an accurate demarcation line between the elites and everybody else. It isn’t “the 1%”, it isn’t white privilege, it isn’t capitalism or managers vs labour.

It’s this:

…click on the above link to read the rest of the article…

Bank of Canada Announces Provincial, Corporate QE

Bank of Canada Announces Provincial, Corporate QE

While the Bank of Canada kept its overnight rate at 0.25% as expected – as the alternative after three consecutive rate cuts would have been to cut below its effective lower bound of 0.25% and go NIRP – the central bank – which announced that the outlook is too uncertain at this point to provide a complete forecast – did surprise markets by joining the unprecedented QE bandwagon, when it announced that just like the Fed it would launch $10BN corporate QE (just investment grade for now, thank you, junk bonds coming next), while throwing in $50BN provincial QE to boot. It also

Some details, from the report:

The Bank is also announcing today the development of a new Provincial Bond Purchase Program of up to $50 billion, to supplement its Provincial Money Market Purchase Program. Further, the Bank is announcing a new Corporate Bond Purchase Program, in which the Bank will acquire up to a total of $10 billion in investment grade corporate bonds in the secondary market. Both of these programs will be put in place in the coming weeks. Finally, the Bank is further enhancing its term repo facility to permit funding for up to 24 months.

These measures will work in combination to ease pressure on Canadian borrowers. As containment restrictions are eased and economic activity resumes, fiscal and monetary policy actions will help underpin confidence and stimulate spending by consumers and businesses to restore growth. The Bank’s Governing Council stands ready to adjust the scale or duration of its programs if necessary. All the Bank’s actions are aimed at helping to bridge the current period of containment and create the conditions for a sustainable recovery and achievement of the inflation target over time.

…click on the above link to read the rest of the article…

The Angels Are Freefalling: Q1 Saw Record Downgrades To Junk And The Real Pain Is Coming

The Angels Are Freefalling: Q1 Saw Record Downgrades To Junk And The Real Pain Is Coming

Back in November of 2017, this website was the first to suggest that a flood of “fallen angels”, or the lowest, BBB-rated investment grade bonds that are downgraded to junk, will be the event that triggers the next corporate debt crisis. In “Hunting Angels: What The World’s Most Bearish Hedge Fund Will Short Next“, we quoted from the IMF’s Oct 2017 “Global Financial Stability Report”  which issued an ominous warning:

… BBB bonds now make up nearly 50% of the index of investment grade bonds, an all time high. BBB bonds are only one notch above high yield, and are at the greatest risk of becoming fallen angels, that is bonds that were investment grade when issued, but subsequently get downgraded to below investment grade, or what is known these days as high yield. It then points out that investors have never been more at risk of capital loss if yields were to rise. In addition, it notes volatility targeting investors will mechanically increase leverage as volatility drops, with variable annuities investors having little flexibility to deviate from target volatility

Following this article, the topic of a tsunami in “fallen angel” credits took on greater urgency, because with over $3 trillion in bonds on the cusp of downgrade, as we discussed in “The $6.4 Trillion Question: How Many BBB Bonds Are About To Be Downgraded“, countless asset managers warned (herehere and herethat this was the biggest threat to the credit pillar of both the US economy and stock market (recall the bulk of BBB rated issuance was used to fund the trillions in buybacks that levitated the stock market over the past few years).

In Unprecedented Move, Fed Unveils Open-Ended QE Including Corporate Bonds

In Unprecedented Move, Fed Unveils Open-Ended QE Including Corporate Bonds

Coming into Monday, the Fed had a problem: it had already used up half of its entire emergency $700BN QE5 announced last weekend.

Which, together with the plunge in stocks, is why at 8am on Monday, just as we expected – given the political cover they have been provided– The Fed unveiled an unprecedented expansion to its mandate, announcing open-ended QE which also gave it the mandate to buy corporates bonds (in the primary and secondary market) to unclog the frozen corporate bond market as we just one step away from a full Fed nationalization of the market (only Fed stock purchases remain now).

As noted elsewhere, the Fed’s new credit facilities carry limits on paying dividends and making stock buybacks for firms that defer interest payments, but have no explicit restrictions preventing beneficiaries from laying off workers.

Additionally, in addition to Treasuries, The Fed will buy Agency Commercial MBS all in unlimited size.

The Fed will buy Treasuries and agency mortgage-backed securities “in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy,” and will also buy agency commercial mortgage-backed securities, according to a statement.

The Fed also said it will support “the flow of credit to employers, consumers and businesses by establishing new programs that, taken together, will provide up to $300 billion in new financing.” It will be backed by $30 billion from the Treasury’s Exchange Stabilization Fund.

Coincidentally, this unprecedented action takes place just hours after real estate billionaire Tom Barrack (and friend of Trump) said the U.S. commercial-mortgage market is on the brink of collapse and predicted a “domino effect” of catastrophic economic consequences if banks and government don’t take prompt action to keep borrowers from defaulting.

…click on the above link to read the rest of the article…

Weekly Commentary: $150 Billion Global Corporate Bond Binge

Weekly Commentary: $150 Billion Global Corporate Bond Binge

After an extraordinary August, markets are showing no inclination for stability to begin September. Jumping 1.3% Thursday on news of an October restart of trade talks, the S&P500 gained 1.8% for the week. The S&P500 ended the week less than 2% from all-time highs. The Semiconductors surged 4.2%, increasing 2019 gains to almost 36%. The Nasdaq100 advanced 2.1% (up 24.1% y-t-d), now also less than a couple percent from record highs. The Broker/Dealers jumped 2.7%.  

Not uncharacteristically, the more dramatic market trading dynamics were visible throughout fixed-income. Curiously, Thursday’s bout of “risk on” (and much stronger-than-expected ADP and ISM Non-Manufacturing reports) finally captured the attention of safe haven bonds. Ten-year Treasury yields surged nine bps to 1.56% – which equated to a painful 1.8% one-day drop in the popular iShares Treasury Bond ETF (TLT). Intraday, TLT was down as much as 2.4%. Bullish pundits were quick to dismiss a single-session yield jump. But of the crowd piling into bond ETFs, how many are unaware of how quickly money can be lost in “safe” bonds?

“Biggest Bond Rout in Years Whiplashes Bulls Who Were Right,” read a Bloomberg article (Liz McCormick) headline. Jumping 9.5 bps to 1.53%, two-year Treasury yields posted their largest one-day jump since February 2015. At one point up 14 bps, two-year Treasury yields were on the cusp of the biggest single-session spike in a decade. Interestingly, the implied yield for December Fed funds futures was little changed for the week at 1.61%.

Investment-grade corporate bonds were under pressure as well. The iShares Investment-Grade Bond ETF (LQD) was down as much as 0.9% intraday before ending Thursday’s session with a loss of 0.7%. While declining almost 1% early in the trading day, the “risk on” backdrop lifted junk bond indices into positive territory by the close.

 …click on the above link to read the rest of the article…

“That’s a Super Dangerous Place to Be”: CEO of JPMorgan Asset Management

“That’s a Super Dangerous Place to Be”: CEO of JPMorgan Asset Management

When central banks distort the markets, risk disappears from view.

“You could have a bunch of walking-zombie companies and you don’t even know it,” explained Mary Callahan Erdoes, CEO of JPMorgan Asset Management, on Wednesday at the Delivering Alpha Conference in New York. “That’s a super dangerous place to be,” she said.

She was talking about the effects of the ECB’s bond buying program as part of a broader warning that investors are no longer seeing risks.

The ECB has been buying corporate bonds, among other things, in an explicit effort to distort the bond market and drive corporate bond yields to near zero. At the peak of the frenzy last fall, the average euro junk-bond yield fell to 2.08% — though it has risen since. These are bonds with an appreciable risk of default. But the yield was barely enough to cover inflation (currently 2.0%). Credit risk wasn’t priced in at all.

The bond-buying binge has created a universe of bonds with negative yields, and desperate investors who’ll take any risk without compensation just to cover inflation. This desperation supplies fresh money to burn to even the riskiest zombie companies.

Companies have relentlessly taken advantage of this investor desperation. The amount of corporate euro bonds outstanding has surged by about 45% over the past three years, to €1.5 trillion ($1.75 trillion), including record euro-bonds issued by American junk-rated companies.

When credit risk is not being priced at all – when it’s free – this most important gauge of the credit market is worthless.

“You’re equally rewarding the A-plus student and the student who’s doing no homework and is just showing up,” Erdoes said at the conference, as reported by Bloomberg.

…click on the above link to read the rest of the article…

China Deleveraging Hits Corporate Bonds As Cascade Effect Begins

China Deleveraging Hits Corporate Bonds As Cascade Effect Begins

Following the market lockdown during October’s Party Congress, many commentators were disturbed by the continued rise in Chinese government bond yields as we returned to “business as usual”, with the 10-year rising to 4%. At the beginning of this month, we discussed the sell-off (see “China: Shadow Bank Inflows Are Critical To Sustain The Ponzi…But They’re Falling”) and noted a useful insight from the Wall Street Journal.

An important anomaly to note about the bond rout: as government bonds sold off, yields on less-liquid, unsecured Chinese corporate bonds barely moved.

That is atypical in an environment of rising rates – usually, bond investors shed their less-liquid holdings and hold on to assets that are more easily tradable, like government debt.

The question was…why had corporate bond yields barely moved? The answer, according to the WSJ, was that China’s deleveraging policy led to redemptions in the shadow banking sector, e.g. in the notorious $4 trillion Wealth Management Products (WMP) sector. Faced with redemptions, shadow banks had to sell something…quickly…and highly liquid government bonds were the “easiest option”. Furthermore…and this is potentially significant…the WSJ noted.

Meanwhile, the nonbanks have held on to their higher-yielding corporate bonds, which at least have the benefit of helping them to maintain high returns.

Not any more (see below).

We agreed with the WSJ’s explanation at the time, but noted that the government bond sell-off was actually a sign of the unravelling of the WMP Ponzi scheme. The Chinese authorities are wise to the Ponzi which is why they announced the overhaul of shadow banking and WMPs last Friday (see “A ‘New Era’ In Chinese Regulation Means Turmoil For $15 Trillion In China’s ‘Shadows”). However, the new regulations don’t kick in until mid-2019, a sign to us that when they looked “under the bonnet”, they didn’t like what they saw.

…click on the above link to read the rest of the article…

David Stockman: Thanks for the Corporate Bond Bubble, Fed

Once upon a time businesses borrowed long term money—-if they borrowed at all—-in order to fund plant, equipment and other long-lived productive assets. That kind of debt was self-liquidating in the sense that it usually generated a stream of income and cash flow that was sufficient to service and repay the debt, and to kick some earned surplus into the pot as well.

Today American businesses are borrowing like never before—-but the only thing being liquidated is there own equity capital. That’s because trillions of debt is being issued to fund financial engineering maneuvers such as stock buybacks, M&A and LBOs, not the acquisition of productive assets that can actually fuel future output and productivity.

So it amounts to a great financial shuffle conducted entirely within the canyons of Wall Street. Financial engineering deals invariably shrink the float of outstanding stock among the companies visiting underwriters. Likewise, they invariably leave with the mid-section of their balance sheets bloated with fixed obligations, while the bottom tier of shareholder equity has been strip-mined and hollowed out.

At the same time, none of this vast flow of capital leaves a trace on the actual operations—-such as production, marketing and payrolls—of the businesses involved. Instead, prodigious sums of debt capital are being sold to yield-hungry bond managers and homegamers via mutual funds and then recycled back into windfall gains for stock market gamblers who chase momo plays and the stock price rips that usually accompany M&A, LBO or stock buyback announcements.

Needless to say, central bank financial repression is responsible for this destructive transformation of capital market function.

…click on the above link to read the rest of the article…

Dollar-Denominated Corporate Time Bomb Set to Blow

Dollar-Denominated Corporate Time Bomb Set to Blow

Emerging economies around the world are already feeling the first pangs of withdrawal as fast yield-chasing investors send their funds back to the U.S. in anticipation of higher Treasury yields and a further appreciating dollar.

In Mexico, the central bank has just published its balance of payments data for the third quarter, 2015. The results do not make for pretty reading.

Early Signs of a Stampede

Net portfolio investment – the total amount of foreign money spent on Mexican financial assets – clocked in at a paltry €933 million, down from $4.47 billion during the same quarter last year. That’s a 79% drop. It was also Mexico’s fifth successive quarterly decline and the lowest level recorded since 2002. Although the rout was across the board, it was particularly pronounced in the private sector which suffered a €241 million net outflow of funds.

Interestingly, while portfolio investment stagnated, foreign direct investment (FDI) flourished, growing by 57.6% in the first nine months of 2015. In other words, those who are investing for the long haul continue plowing funds into Mexico. Which is wonderful news — in the long term! The problem is that investors who are after the quickest of monetary fixes are frantically moving their money out. And that is bad news in the short term! Crises are made of this phenomenon.

And right now, with monetary pressures building around the globe, it’s the short term that counts.

Since the U.S. Federal Reserve alighted on its madcap scheme to flood the global economy with dirt cheap, easy-come-easy-go dollars, high-yield seeking “investments” have poured into emerging markets. Much of the money ended up in Mexico, one of comparatively few Latin American economies to have completely liberalized its financial sector.

…click on the above link to read the rest of the article…

This is When Bonds Go Kaboom!

This is When Bonds Go Kaboom!

The toxic miasma of “distressed debt.”

It’s getting tougher out there for our QE and ZIRP-coddled corporate junk-bond heroes.

Unisys, whose revenues and profits decline year after year and whose stock dropped from over $400 a share during the prior tech bubble to $13 a share now, withdrew its offer to sell $350 million of bonds on Friday.

The “current terms and conditions available in the market were not attractive for the company to move forward,” it said. According to S&P Capital IQ’s LCD, the five-year senior secured notes due in 2020, rated BB/Ba2, had been guided at around 8%. But buyers were leery, and they demanded more yield. They wanted to be rewarded just a little more for the substantial risk they were taking. So the notes failed to price, and Unisys withdrew the offering.

Unisys isn’t an oil company, or a mining company, or a coal company – sectors that have been eviscerated by the commodities rout and are having trouble issuing any debt at all. Unisys is a tech company.

But Unisys wasn’t the only one: It was the 15th bond offering withdrawn so far this year, according to LCD, though two of them – Fortescue Metals and Presidio – were able to pull them off later. In total, nearly $4 billion in bond offerings were withdrawn this year.

Olin Corp., which manufactures chlor-alkali products, wasn’t that lucky. It had to havethe money to fund its acquisition of the chlorine products business of Dow Chemical. Its $1.5 billion offering came in two tranches: eight-year notes and 10-year notes, guided around 6.5% and 6.75% respectively. But investors sniffed at them and lost their appetite. LCD reported on Thursday that they were pushing for yields “in the mid-to-high 7% range.”

But that wasn’t enough either. On Friday, Olin ended up selling $1.22 billion of bonds, with the eight-year notes priced to yield 9.75% and the 10-year notes 10%.

…click on the above link to read the rest of the article…

“Risky Business”: Companies Are Now Funding Share Buybacks By Selling Bonds To Other Companies

“Risky Business”: Companies Are Now Funding Share Buybacks By Selling Bonds To Other Companies

One of this year’s key narratives has been the degree to which US stocks have benefited from a perpetual, price insensitive bid. By that we of course mean corporate buybacks, which one might fairly characterize as having replaced the monthly flow lost to the Fed taper.

The buyback bonanza shown above is of course sponsored by ZIRP. Put simply, when borrowing costs are close to zero and when the market has become completely myopic as it relates to assessing performance, it makes sense to issue debt and plow the proceeds into EPS-inflating share repurchases. Throw in the fact that the FED-induced hunt for yield has forced risk averse investors out of govies and into corporate credit and you have a kind of goldilocks scenario for corporate issuance and buybacks.

This all comes at cost. That is, you can’t simply keep leveraging the balance sheet to artificially inflate earnings. Eventually, some of the proceeds from debt sales need to go towards capex or wage growth or something that’s conducive to boosting productivity, long-term growth, and competitiveness. However, that simply won’t happen in a world governed by what Hillary Clinton correctly (yes, she has managed to get at least something right believe it or not) calls the “tyranny of the next earnings report.”

Once you understand all of the above, you can begin to see why a lack of market depth in the secondary market for corporate credit is so dangerous.

 

You have an environment that encourages record issuance and the proliferation of bond funds along with the now ubiquitous hunt for yield means any and all supply is promptly snapped up. But if those bonds ever have to be sold in a pinch, there’s no one home at dealer desks thanks to Volcker.

…click on the above link to read the rest of the article…

 

 

The Lesson In China: Don’t Go Bubble In the First Place

The Lesson In China: Don’t Go Bubble In the First Place

There can be no mistaking that Chinese stocks are in a bubble. Since November 21, the Shanghai SSE Composite index has risen more than 100%. Going back to July 22, the gain is nearly 145%. Those dates are not random coincidence, as they mark specific points of PBOC activity. The stock bubble in China is certainly a monetary affair, but in ways that aren’t necessarily comparable to our own stock bubble experience (twice).

There is, of course, great similarities starting with leverage; in China at the moment there is no shortage, which is precisely the problem. It is quite precarious, though, in that the PBOC has at times shown far more open contempt for Chinese stock margin than the Federal Reserve or Bank of Japan ever did.

Stock forecasters in search of an early-warning system for the next Chinese bear market are zeroing in on the country’s record $358 billion pile of margin debt.

When that three-year build-up of leveraged positions starts to unwind, regulators will struggle to limit the selloff, according to Bocom International Holdings Co. and Rabobank International. Almost all of this year’s biggest declines in the Shanghai Composite Index, including a 6.5 percent slump on May 28, were sparked by investor concerns over margin-trading restrictions. The securities regulator announced plans Friday to limit the amount brokerages can lend for stock trading.

Unlike central banks here and elsewhere, the PBOC has a vastly different understanding and appreciation for asset bubbles, at least to the point that in 2014 and 2015 under reform it is not shirking responsibility for them. The Federal Reserve, in particular, had long been against any linkage between monetarism and asset bubbles, believing instead that they were fully contained under “market” irregularities (that has evolved, somewhat, under the relatively new Yellen Doctrine). I’m not sure the PBOC ever went so far as to completely delink its own activities from asset bubbles, but it at one point was clearly embracing of them even if reluctantly part of a greater government mandate.

 

…click on the above link to read the rest of the article…

Central Banks Warn: Liquidity May Evaporate When Investors Finally Remove Blindfolds

Central Banks Warn: Liquidity May Evaporate When Investors Finally Remove Blindfolds

Companies are selling bonds like madmen. This year through Tuesday, investment-grade and junk-rated companies have sold $438 billion in new bonds, up 14% from the prior record for this time of the year, set in 2013, according to Dealogic. This quarter is already in second place, nudging up against the all-time quarterly record of $455 billion of Q2 2014.

About $87 billion of these bonds funded takeovers, a record for this time of the year, the Wall Street Journal reported. The four biggest bond sales in that batch were for healthcare takeovers, including the Actavis deal whose $21 billion bond sale was the second largest in history, behind Verizon’s $49 billion bond sale in 2013.

Actavis had received orders for more than four times the bonds available, according to CFO Tessa Hilado. “You don’t really know what the demand is until people start placing their orders,” she said. “I would say we were pleasantly surprised.”

Brandon Swensen, co-head of U.S. fixed income at RBC Global Asset Management, couldn’t “see anything on the radar that’s going to slow things down materially,” he told the Wall Street Journal. His firm expects rates to “remain low.”

All of the investors chasing after these bonds expect rates to remain low. Or else they wouldn’t chase after these bonds. If rates rise, as the Fed is promising in its convoluted cacophonous manner, these bonds that asset managers are devouring at super-high prices and minuscule yields are going to be bad deals. And their bond funds are going to take a bath.

 

…click on the above link to read the rest of the article…

Thanks For The Corporate Bond Bubble, Fed

Thanks For The Corporate Bond Bubble, Fed

Once upon a time businesses borrowed long term money—-if they borrowed at all—-in order to fund plant, equipment and other long-lived productive assets. That kind of debt was self-liquidating in the sense that it usually generated a stream of income and cash flow that was sufficient to service and repay the debt, and to kick some earned surplus into the pot as well.

Today American businesses are borrowing like never before—-but the only thing being liquidated is there own equity capital.That’s because trillions of debt is being issued to fund financial engineering maneuvers such as stock buybacks, M&A and LBOs, not the acquisition of productive assets that can actually fuel future output and productivity.

So it amounts to a great financial shuffle conducted entirely within the canyons of Wall Street. Financial engineering deals invariably shrink the float of outstanding stock among the companies visiting underwriters. Likewise, they invariably leave with the mid-section of their balance sheets bloated with fixed obligations, while the bottom tier of shareholder equity has been strip-mined and hollowed out.

At the same time, none of this vast flow of capital leaves a trace on the actual operations—-such as production, marketing and payrolls—of the businesses involved. Instead, prodigious sums of debt capital are being sold to yield-hungry bond managers and homegamers via mutual funds and then recycled back into windfall gains for stock market gamblers who chase momo plays and the stock price rips that usually accompany M&A, LBO or stock buyback announcements.

 

…click on the above link to read the rest of the article…

Olduvai IV: Courage
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Olduvai II: Exodus
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