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 In the latest week, $241.2 million were withdrawn from high-yield mutual funds and ETFs.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