Bond offerings set a new record in 2014, but junk bonds deflate
Just about every aspect of the US credit bubble is setting new records these days. Now corporate bond sales did it: they punched through the $1.5-trillion mark, beating the full-year record of $1.49 trillion in 2013. It’s a feeding frenzy – corporations and Wall Street feeding on cheap investor money before rates go up.
On Tuesday, Amazon went back to the till to take $6 billion in new money from investors via another bond sale, after having sold $3 billion two years ago. Debt is piling up. Excluding what it owes its suppliers, Amazon ended 2011 with $2.6 billion in debt; by last quarter, the pile had grown to $8.4 billion. This quarter, an additional $6 billion will be piled on top. Profit-challenged Amazon needs the money: last quarter, it booked the largest operating loss in its history.
On Monday, it was Medtronic that went to the till for $17 billion in new money, the largest bond sale this year. It needs the money not to expand its research facilities or operations or anything else productive, but to buy surgical gear maker Covidien. The deal beat the other mega deals this year, such as Alibaba’s $8 billion bond offering two weeks ago or GE’s $13.2 billion offering and Verizon’s $14.8 billion offering earlier this year.
Like many of its corporate brethren, Verizon is already drowning in debt, after a borrowing binge that included the record-breaking $49 billion bond offering last year to help pay for its acquisition of Vodafone’s share of Verizon Wireless.
Amazon’s deal pushed investment-grade bond sales so far this year to $1.174 trillion. Junk bonds have been red-hot too. The current sales of $344 billion are just a notch from the 2013 record of $348 billion, according to Bloomberg. That record is likely to fall shortly. In total so far this year, corporations have collected $1.518 trillion in new money from investors via bond sales alone, the most ever.
Companies are taking advantage of enticingly low borrowing costs while they still can. And they don’t waste their energy investing the proceeds in productive activities, such as capital expenditures or expansion plans. Instead, they’re using the money to buy back their own shares, pay dividends, and acquire other companies.
Timing couldn’t be better. In this super-expensive market, they’re overpaying for their own shares; and they’re overpaying for other companies by adding huge premiums to already inflated stock prices. Wall Street, which gets fat from the fees, provides the requisite hoopla.
It’s a perfect use of debt. Instead of creating something that will generate an income stream with which to service and pay off the debt, corporations are blowing the proceeds. This works wonderfully as long as ever cheaper new debt is available to service and pay off old debt.
For investors, it has been a great deal too, thanks to the Fed’s interest rate repression and QE, and its jawboning that markets so love because it signals to everyone in which direction to run all at the same time, screaming, “Don’t fight the Fed.” The simultaneous buying inflates prices and represses yields. Bond investors have been rewarded at every twist and turn of the yield repression saga not with adequate yields, but with higher prices for their bonds.
New money has been pouring into corporate investment-grade bond funds for 24 weeks in a row, according to Lipper. But junk-bond funds have had a more mixed experience recently as investors are beginning to get cold feet.
Prices of junk bonds (rated BB or lower) have been falling from record levels in June, and the yield has zigzagged up nervously from 4.2% in June to 4.98% on Tuesday. Among junk bonds rated CCC or lower, the underbelly of over-indebted corporate America, outright ugliness is starting to spread: the yield jumped from 7.94% in June to 10.69% on Tuesday, the highest yield since December 2012, higher even than during the nerve-racking taper tantrum last year.
The swoon in junk bonds is in part due to the rout in the oil and gas sector. The fracking revolution was largely funded with debt, based on a scenario of ever increasing oil prices. But oil prices have plunged nearly 40% since June. And the bloodletting is spreading [read… Saudi Arabia Declares Oil War on US Fracking, hits Railroads, Tank-Car Makers, Canada, Russia; Sinks Venezuela].
Yield-desperate investors are beginning to bleed. They’d been pushed into this stuff by the Fed’s increased determination back in 2012 to create the biggest credit bubble in history by unleashing QE3. Wall Street touted it ingeniously as “QE infinity” to let investors know that this period of near-zero yield would last forever, and that they’d have to close their eyes and hold their noses and blindly trust Wall Street and pick up even the riskiest junk to earn any yield at all. And it worked wonderfully.
But now, “QE infinity” has been tapered out of existence, and the Fed is threatening to raise rates in 2015. The scheme is coming unglued. The money for junk bonds is drying up for individual companies, leaving bondholders to grapple with the sordid meaning of “junk.” Read…. Junk Bond Carnage, One Company at a Time
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