Wolf Richter: This is When Bonds Go Kaboom!

By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Wolf Street.

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But Unisys wasn’t the only one: It was the 15th bond offering withdrawn so far this year, according to LCD, though two of them – Fortescue Metals and Presidio – were able to pull them off later. In total, nearly $4 billion in bond offerings were withdrawn this year.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

In the energy sector, the bond devastation is even worse.

California Resources – Occidental Petroleum’s spinoff of its oil-and-gas assets in California, a masterpiece of Wall Street engineering – has done nothing but burn investors in its 10 months as an independent company. When I last wrote about it ten days ago, its $2.25 billion of 6% notes due 2024, issued at par to QE-drunk investors in September last year, had plunged to 66 cents on the dollar. Now they’re at 59.5 cents on the dollar [read… A Spinoff Goes to Heck, after Just 10 Months].

Chesapeake Energy, the second largest natural gas driller in the US, is also facing the music. Two of its brethren, Quicksilver Resources and Samson Resources, have already filed for bankruptcy. When I last wrote about Chesapeake a month ago, its $1.1 billion of 5.75% notes due 2023 – that in June 2014 had been at 112 cents on the dollar – had plummeted to 70. Now they’re at 67 [read… Whose Capital Is Getting Destroyed in US Natural Gas?].

Oil and gas producer Halcon Resources, which has been demolishing its investors via serial debt exchanges that are becoming the model for distressed companies, saw its 8.875% notes due 2021 drop to 33.5 cents on the dollar. And darling Linn Energy saw its 6.5% notes due 2021 collapse to 23 cents on the dollar.

They’re in the toxic miasma of “distressed debt,” bonds that are deemed to be in so much trouble that their yields have soared to where the spread between their yields and the yield of US Treasuries has hit or surpassed 10 percentage points.

Standard & Poor’s, which tracks the “distress ratio” it its Distressed Debt Monitor, announced on September 24, that the distress ratio, after rising since late last year, hit 15.7%, the worst level since December 2011.

Oil and gas accounted for 95 of the 270 bonds in that elite club and sported the second-worst sector distress ratio of 41.9%. The metals, mining, and steel sector, with 47 bonds in the club, had the worst sector distress ratio of 53.4%. Rising distress levels are a leading indicator for defaults. And defaults have already been creeping up.

This chart from LCD HY Weekly shows the distress ratio of leveraged loans as measured by S&P Capital IQ LCD (blue line) and of junk bonds as measured by BofA Merrill Lynch (red line) which depicts reality in an even harsher light than Standard and Poor’s. Leveraged loans are generally secured and hold up better in a bankruptcy than bonds. But distress levels of both have recently begun to spike:



These yields that are rising to distressed levels drive up the spread between corporate bond yields and US Treasury yields. The spread is a measure of perceived risk. It had dropped to ludicrously low levels. This wasn’t a function of risk somehow disappearing from Planet Earth. It was a function of the Fed’s beating investors into submission with its zero-interest-rate policy so that they would eliminate risk as a factor being priced into their calculus. Now risk is re-inserting itself into the calculus. And look what happened.

Investors are suddenly discovering an idea – the very one the Fed in its infinite wisdom has beaten out them: they want to be compensated at least a tiny bit for taking on huge risks. And now spreads have begun tentative efforts to spike, “tentative” because history shows that they can blow through the roof:



The chart by S&P Capital IQ LCD is based on LCD’s “high-yield flow names,” junk-rated companies whose bond issues are large and frequently traded. They include in alphabetical order: California Resources, Charter Communications, Chrysler, Community Health… and so on, all the way down to Sprint and Valeant Pharmaceuticals.

Rising spreads make raising money more expensive to get, and for the biggest sinners – the very companies that must get new money or fail – impossible to get. Investors will try to stay out of harms way. In this manner, spiking spreads lead to rising distress, and rising distress leads to rising defaults. And that’s when these bonds go kaboom.

But the $40-trillion US bond market is not an entity by itself. Many of these companies are publicly traded, and stockholders are at the low end of the capital totem pole. Even the lowliest, most kicked-around unsecured bondholders come ahead of them. That’s how problems in bond land tear into stocks. To get an idea where Chesapeake’s and Olin’s stocks are headed, watch their bonds.

These rising spreads – regardless of what the Fed will do in terms of flip-flopping on interest rates – is a very bearish signal for stocks. But according to our soothsayers, there should have been a big rally. Read… What the Heck’s Happening to the Global Stock Markets?

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  1. financial matters

    “But the $40-trillion US bond market is not an entity by itself. Many of these companies are publicly traded, and stockholders are at the low end of the capital totem pole. Even the lowliest, most kicked-around unsecured bondholders come ahead of them. That’s how problems in bond land tear into stocks.”

    Very good point. Who is going to support these bond holders? The Fed or the stockholders?

    1. craazyboy

      The definition of junk bonds is that the company will never be able to pay off bond debt from cash flow. They can only do it by issuing new bonds to pay the old. Hence the problem when the market demands higher rates on new bond issues.

      The fact that we have a large junk bond market means we have de-facto institutionalized what is also pretty close to the definition of a Ponzi scheme. But in ZIRP_WORLD who doesn’t like some “real return”. (provided you don’t give it all back in principal loss)

      The age old solution to this Catch 22 is bankruptcy. Here the stockholders are wiped out, the bondholders forgive debt (not so willingly, of course) in exchange for new equity in the company. The company has been freed of it’s debt burden, and may have a chance to turn into a successful growing biz again.

      Why we don’t see this process happening more often is a mystery to me.

      1. Jim Haygood

        Can’t compete with your songwriting partnership with Dylan. But here’s a tune for the day, Junk Bond Hero:

        Standing in the rain, with his head hung low
        Couldn’t get a bid, it was a sold out show
        Heard the roar of the traders, he could picture the scene
        Put his ear to the wall, then like a distant scream
        He heard trading halt, just blew him away
        He saw doom in his eyes, and the very next day

        Bought a credit default swap in a secondhand store
        Didn’t know how to trade it, but he knew for sure
        That CDS felt good in his hands
        Didn’t take long to understand
        Just one big swap, with junk way down low
        Was a one way ticket, only one way to go
        So he started shortin’, ain’t never gonna stop
        Gotta keep on shortin’, someday gonna make it to the top

        And be a junk bond hero, got doom in his eyes, he’s a junk bond hero
        Junk bond hero, (doom in his eyes) he’ll cash out tonight

    2. ella

      If history is any guide, I suggest we look at ourselves in the mirror because we bailed them the last time. Doubtful, if they have learned any lessons. Remember who hold the CDS’… Banks

  2. say_what?

    But the $40-trillion US bond market is not an entity by itself. Many of these companies are publicly traded, and stockholders are at the low end of the capital totem pole. Even the lowliest, most kicked-around unsecured bondholders come ahead of them. That’s how problems in bond land tear into stocks. Wolf Richter [bold added]

    Which is why, if we insist on government subsidized private credit creation to drive individuals and corporations into debt, that we MUST* have a fiscal policy to provide the interest and profits required thereby?

    Shorter, lose monetary policy requires lose fiscal policy too? For a net importer?

    *Since we (the US) are a net importer.

    1. financial matters

      I think this is useful to get into sectoral balance analysis with 3 ‘sectoral balances’ which includes government and non-government and non-govenment is divided into foreign and domestic. The foreign is the current account (the difference between imports and exports).

      Government = private sector (household plus business) + current account

      Right now the US govt is responding appropriately by increasing deficits but it’s mostly directly to business (esp financial and the 1%).

      We have fiscal space by being able to run deficits but we need better fiscal direction to get that money into the hands of the 99% who tend to get that money moving into the real economy.

      It means not printing money and giving it to the banks for speculation but spending money into the productive side of the economy.

      I think we could do better in using our money, (the Fed), than buying up these stocks and bonds.

  3. Jim Haygood

    ‘The metals, mining, and steel sector, with 47 bonds in the club, had the worst sector distress ratio of 53.4%.’

    As ol’ Dostoyevsky said, ‘So things are bad? Well then, let them get even worse.’ Case in point, witness the eminent Dr Copper (PhD Econ), dog-sick and barfing in the gutter. Chart:


    At $2.25/lb, copper is just a couple of cents off its Aug 24th Black Monday panic low. TA (technical analysis, not the other kind of T & A) says that if the Aug 24th low breaks, we’s in bad trouble.

    Meanwhile, two popular junk bond funds, HYG and JNK, both are down more than one percent at lunchtime. Nice timing, Wolf.

  4. susan the other

    capitalism doesn’t promise anyone a return on their investment. at this rate it will fade fast.

    1. ella

      Wait, the 1% demands and receives tax entitlements, favorable government contracts, the FED PUT and other FED goodies, deregulation, and little to no punishment for fraud. And that is not even the tip on the iceberg. They are guaranteed a return on their investment. Here’s to the Welfare Kings, they got the system down.

  5. Fool

    Months ago I criticized Mr. Wolf’s doomsaying with respect to the energy (junk bond) market. (In my defense, though, I heard through the grapevines that Mike Milken was putting together a fund in that area (not in his name, of course, since he’s barred, but I digress).) Anyway, I would like to come out and say that I was wrong and am an idiot and that Wolf was right and is smart.

    Namaste :)

  6. steelhead23

    Methinks this is serious. After all, NC seldom prognosticates about the markets – leaving that game to ZH and others. Hence, if NC deigns to discuss this little “correction” in the baa corporate bond market, the hint seems to be “take cover.” This portends a significant debt deflation. BTW – I would not be so sanguine that Uncle Sam will do a HARP for corporate bonds. There are big players on both sides of that street and I can’t see Obama choosing winners and losers among his friends.

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