General Cable (BGC), a copper, aluminum, and fiber-optic cable and wire maker with $6.2 billion in revenues, made an announcement on Monday that caused its already beaten-down stock to drop another 6.5%: it withdrew its offering of $250 million in senior unsecured junk-rated notes.
Due to “uncertain and weak overall conditions in the high yield debt market,” the statement said. Issuing the debt now “would not be in the best interest of shareholders under terms currently available,” CEO Gregory B. Kenny explained.
Junk-bond default rates have been very low; as long as old debt can be replaced easily and more cheaply with new debt, and as long as new losses and negative cash flows can be funded with new debt, default isn’t necessary. Investors cling to this notion by their fingernails to rationalize the record low yields they’re accepting.
It’s a self-propagating cycle: new money chases yield and finds it in junk, and it allows companies to avoid the hard truth as everything gets funded, and default rates drop, which brings in even cheaper money to replace old wobbly debt and fill operating sinkholes, and risks disappear from the equation since new money can always keep a company afloat.
Which is precisely what General Cable proclaimed on September 22 when it announced the debt deal: it would use the proceeds “to address the maturity of the 2015 floating rate notes and prefund the restructuring program.” So pay off old debt and fund new losses.
At the time, Moody’s Investors Service affirmed the company at B2, knee-deep into junk, with negative outlook. Given the prospect of new money coming in, Moody’s raised the company’s Speculative Grade Liquidity assessment to SGL-3 from SGL-4. Then on Monday, after the debt offering was withdrawn, Moody’s downgraded the liquidity rating back to SGL-4.
The stock tanked. Investors saw a higher probability of default as the company might have difficulty funding its losses or refinancing its maturing debt at rates it can afford. And then there’s that favorite financial engineering scheme with which Corporate America has relentlessly driven up their shares to ludicrous heights: share buybacks.
General Cable’s $125 million share buyback program was extended in December. At the time, the company had bought back $19 million in shares under the program; the unused $106 million were carried over into this year.
By the end of the second quarter on June 27, the repurchase authorization was down to $75 million. At the same time, net debt increased by $104 million to $1.26 billion. But on Monday, investors expecting the $75 million to provide support under the stock were smacked down. The company would have to tighten its belt. It would have to use its resources to fund its losses. And investors kissed their last hope of share buybacks goodbye.
Last hope because in Q2, the company had already stopped repurchasing its shares due to limits imposed on it by its debt covenants.
Not that the company hadn’t warned about this debacle in the small print at the bottom of its Q2 earnings report. After some lingo about “actual results may differ materially,” it listed a whole slew of those risks that could cause actual results to differ, including its ability issue debt and repurchase shares.
The company’s stock tends to be one of the precursors for the rest of the stock market: it peaked at $83 a share in July 2007, as the junk bond market was already cracking, but four months before the S&P 500 peaked. From that lofty perch it plunged to below $8 by November 2008. Then, while the S&P 500 was still in freefall, BGC began soaring. By the time the market bottomed out in March 2009, BGC had more than doubled. It continued zigzagging up to nearly $50 in April 2011. Those were the good times.
When the company stopped repurchasing its shares sometime in the first quarter, it removed the last prop under the stock. From this year’s high in February of $31.40, the stock turned south. On Monday it dropped another 6.5% to $15.45 – down 51% in seven months.
But BGC is not in the S&P 500 index. This kind of blood-letting takes place beneath the surface and won’t show up in the S&P 500 until damage spreads to S&P 500 companies.
September has been a bitch for junk bonds. Cancelling debt offerings isn’t exactly common. For the first eight months of the year, five companies cancelled debt offerings. But in September alone, five more companies, including General Cable, did so. The SPDR Barclays High Yield Bond ETF (JNK) is down 3.4% so far this month. And the BofA Merrill Lynch High Yield index, after hitting all-time record highs in June, lost its footing in September. Effective yields jumped from 5.54% at the beginning of the month to 6.55% on Monday.
When nearly free money is sloshing through the system, and when yield-desperate investors hold their noses and close their eyes as they pick up anything just to get a little extra yield though the Fed decreed that there should be no yield, and when they’re taking on any risk without a second thought or real compensation, then defaults become rare; troubled companies simply borrow new money to pay off old money. And until June, no time in history provided more opportunities for junk-rated companies to issue cheaper debt.
Now things have turned. Investors are shyly asking a few questions, and they briefly take a whiff, and they’re actually glancing at the paper they’re picking up, and they’re seeing some risks, and they want to be paid a little more for taking on those risks.
Surely, General Cable hopes that this junk bond swoon too will pass, as those before, and that yields will once again drop to record lows. But the Fed is fretting about “financial instability” and has fingered junk debt as one of the elements. It’s tightening and may raise rates next year to stop this very madness its policies have caused. And suddenly, borrowing new money to pay off old money and to fill operating sinkholes becomes a lot more expensive for junk-rated companies, and borrowing money to buy back shares – well, forget it.
The tremors in the junk bond market are followed by tremors in the stock market via the links of rising default risk and dying buybacks. Plenty of outfits like General Cable have already let go. But these are just the first mild tremors of the historic junk bond bubble that is part of the greatest credit bubble in history.
BofA Merrill Lynch sees four indicators that point at “an inflection point,” as they did in 2008 and 2011. Even relentlessly exuberant VCs are warning. Read…. BofA Merrill Lynch: the Four “Canaries in the Coalmine” Died
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