A “Crush” of Bond Sales Before the Market Goes to Heck

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The scenario that corporations have been feverishly preparing for over the past few years took another step forward on Friday with the release of “robust” jobs data.

It triggered a sell-off in US stocks. Treasuries plunged, and yields jumped, with the 10-year yield reaching 2.24%, up 13 basis points for the day, and up 60 basis points from the low at the beginning of February.

That the US economy gained 295,000 jobs in February on a seasonally adjusted basis, according to the Bureau of Labor Statistics, blew past economists’ expectations. As these kinds of reports pile up, they’ll nudge the Fed to begin raising interest rates by mid-year. The Fed already abandoned QE though Wall Street had hyped the last round as “QE Infinity.” The zero-interest-rate policy would be next; that’s what the ultimate insiders, the decision makers in corporate America, are preparing for. For them, it means the free money, or nearly free money, is going to get more expensive.

They weren’t surprised by the jobs report, unlike the markets. They expected a blowout that would confirm their suspicions that the Fed would begin raising rates in a few months. They’ve been preparing for it by creating the maximum hype about the persistence of ludicrously low yields while simultaneously selling the maximum amount in debt to Fed-blinded investors before it all blows up.

It was a record bond-selling binge. On Thursday, in anticipation of the jobs report, the LCD HY Weekly, by S&P Capital IQ/LCD, reported:

Another breathless week in the high-grade market brought total issuance volume over the past two weeks to a record high total north of $90 billion, under LCD criteria that exclude the substantial amounts of sovereign, quasi-sovereign, supranational, and preferred and hybrid-structure deals. After 28 issuers came to market last week, another 25 swarmed the market from Monday to Thursday, ahead of a Friday employment report expected to feed speculation regarding the imminence of more hawkish Fed policy.

Wall Street has been busy casting doubt on the idea that the Fed is turning “hawkish.” It wants to pressure the Fed to keep the status quo. And it wants to sell overpriced bonds and rake in the fees. But corporate America is not deluded: “Issuers crowded around the second-largest bond offering ever printed” – the Actavis’ $21 billion, 10-part offering – “as M&A again tipped the scales for issuance volume.” The deal that would help fund the $66-billion acquisition of Allergan had orders “that reportedly topped the offering amount by more than four times well….”

And this “crush of other deals around that Actavis offering” – including an $8 billion deal by Exxon Mobil, upsized from $7 billion – found strong demand by investors who still believed that the Fed would keep rates low forevermore. Even junk bonds were resuscitated from their swoon late last year, triggered by the collapse in energy junk bonds. LCD HY Weekly:

Primary market activity ramped up this week as 14 issuers churned out an expected $8.95 billion in supply, which is the second highest total of the year following the Feb. 9-13 period when $11.085 billion priced from 13 issuers. Year-to-date pro-forma volume is $62.67 billion, an 18.5% advance over last year’s pace.

And even junk-rated energy companies came out of hiding during the week to sell bonds and raise money so that they could survive a little longer. In the process, their existing bondholders got a terrible deal.

Oil-and-gas exploration and production companies Comstock Resources and Energy XXI Gulf Coast – whose stocks have plummeted in lockstep 83% since June 2014 – and mega coal company Peabody Energy – whose stock has plunged 91% since March 2011 as it’s losing its battle with natural gas – all went back to the till.

They had to pay double-digit yields for the privilege. For them, the Fed’s free money is already history. Their first- and second-lien offerings were slipped into the capital structure ahead of existing bonds, which dropped in response. But hey, holding junk bonds is risky, despite what the Fed has made yield-desperate investors believe. And by raising cash, they’re buying time – at a steep price for existing bondholders.

Comstock Resources offered $700 million in first-lien notes due in 2020 at a yield of 10% at par. Its existing senior debt got demolished, yielding around 24%.

Peabody’s $1 billion 7-year second-lien notes faced a yield of 10.5% to get done, which caused S&P to downgrade existing senior unsecured debt one notch to B+ and lower its recovery rating by one notch to “5,” denoting a recovery of 10% to 30% in case of a default. It wasn’t pretty for their owners.

Energy XXI’s $1.25 billion offering of second-lien five-year notes sported a yield of 12%, LCD reported. S&P rated them B+ with a recovery rating of “1” – denoting a recovery of 90% to 100% in case of default – given their high level in the capital structure. And the existing bondholders?

Oh my! S&P downgraded $650 million in existing senior notes one notch to CCC+ due to the increased leverage, with negative outlook. Energy XXI had sold them at par in May 2014. During those ten months, they have lost nearly half their value.

Then came Friday, and it knocked the wind out of bond investors, if perhaps only briefly; Wall Street will find other means to rekindle their delusions for as long as possible. Corporate America is not deluded about the credit bubble and its end: it is selling bonds to these investors as if there were no tomorrow.

You can’t blame corporate America. It’s doing what the Fed encouraged it to do: raise trillions of dollars at ludicrously low cost to blow them on financial engineering and M&A. In the case of oil-and-gas related bonds, the moolah funded a drilling boom that has turned into a bust.

Somebody is going to own these bonds that were sold at peak valuations and with tiny yields. Holders of energy junk bonds are already taking it on the chin. But for the rest, there’s a disconnect between what corporate America knows and what Fed-blinded investors refuse to accept: yields will rise, bond prices will fall, a lot of junk will blow up, some high-grade bonds will turn into junk, and those folks with bond mutual funds in their portfolios will lose on both ends.

It has started: “restructuring” and “bankruptcy” are suddenly the operative terms. Read…  “Default Monday”: Oil & Gas Companies Face Their Creditors

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  6 comments for “A “Crush” of Bond Sales Before the Market Goes to Heck

  1. VegasBob
    Mar 9, 2015 at 1:16 am

    My view is that Friday’s bond market action reflects a ‘strong’ payroll report that no one really believes and a ‘robust’ jobs market that doesn’t actually exist.

    One unpleasant reality ignored by Wall Street is that durable goods orders have been in a downtrend for 6 months now, and that is usually one of the first harbingers of impending recession.

    Suppose that my view is wrong and that somehow interest rates actually do rise substantially. What is the likely outcome?

    First, bond prices get hammered. That’s easy and it’s obvious.

    Second, the echo housing bubble deflates, probably rapidly. At the margin, house hunters are buying a monthly mortgage payment, and that payment is going to buy a lot less house if interest rates rise substantially.

    Third, stocks are going to get hammered, perhaps even worse than bonds. The dollar index will soar because investors will finally be able to get yield on higher quality USD investments, while the rest of the world is mired in negative interest rates. A skyrocketing dollar index will crush the profits of huge multinational corporations with extensive overseas operations. And, don’t forget about the trillions of dollars in low-rate corporate bonds that have been issued to fund corporate stock buybacks. Those trillions will have to be refinanced over the next few years at substantially higher rates, further hammering profitability.

    Now throw in a recession, and it’s easy to see stocks plummeting on the order of 60% or more.

    I don’t doubt that at some point interest rates will rise, probably substantially. The question is whether or not that point is rapidly approaching, or whether this is just another Wall Street head fake?

  2. Julian the Apostate
    Mar 9, 2015 at 7:22 am

    So much for ending the week in an upnote. The whole edifice is swaying precipitously, with the investors seeking to get somewhere that might protect them, not necessarily keep them whole but some nook where the building won’t crush them when the quake hits.
    Yesterday I was buying my monthly supplies and noticed a young woman wearing a bright red t-shirt with the crown on top that said “stay calm and let your social worker handle it”. What a perfect epitaph for a doomed system.

  3. Cocoabean
    Mar 9, 2015 at 1:32 pm

    Yes, eventually interest rates WILL rise. But not anytime soon. And it won’t be at the Fed’s behest: the market will act.

    We have sub-zero yields already. These will spread. The “bond vigilantes” will reappear and a rush into real assets will start as a trickle…

  4. mick
    Mar 9, 2015 at 11:01 pm

    Everyone says rates won’t rise, they can’t rise. These folks are in the camp which believes the FED is benevolent, or at least not evil. They believe the FED wants to save the economy, and if that’s true, they’re right, rates can’t rise.

    I don’t subscribe to this view. I believe the FED serves one master, the big banks. Should our interests and theirs converge, the FED will act beneficially to us, but in reality, they’re acting beneficially for the banks.

    I don’t believe the FED is benevolent because I simply watch what they do, and the outcome of their actions. I cannot find one reason to persuade me that the FED serves anyone but the big banks. And if so, then they just might raise rates, because who knows what the banks’ motives are?

    People assume banks don’t want a crash, but banks can make a Killing in a crash when they’re positioned properly.

  5. ERG
    Mar 10, 2015 at 8:04 am

    Rates will go up and there will be a crash with all the Big Players properly positioned. We’ll then see a return to the QE nonsense and the cycle will repeat. The stock market is already beginning to correct as the corporate buy-backs are running out of steam. This is a demand-less, fake, contrived, economy. Metrics are fudged and the ones that cant be fudged are ignored. Who in the hell is going to make capital investments with interest rates rising when they didn’t lift a finger when rates were ZERO?

  6. BondBear
    Mar 11, 2015 at 7:30 pm

    Has any gen-ex-er even heard of STAGFLATION, never mind knowing and understanding its deep implications…

Comments are closed.