The overloaded $1.2 trillion market in junk bonds – bonds issued by high-risk companies – is showing strains and may break down completely.
Years of low interest rates and easy credit have encouraged companies to borrow to buy their own or others’ stocks, to buy other companies, or to expand operations, among other financial adventures.
Investors have been accommodating, using some of that low-interest money to chase the high yields that riskier bonds offer.
As a result, bonded corporate debt has risen to a record $10 trillion, most of which has been expected to be repaid on time.
The virus pandemic’s economic disaster has put that expectation in doubt, especially for the 12 percent of bonds considered high-risk or, in other words, junk.
Investors have added $400 billion in junk bonds since 2015.
Because of regulations resulting from the Great Recession, the banks that make the loans no longer hold them. Instead, they sell the bonds to fund managers or bundle them into complex investment vehicles called “collateralized loan obligations,” or CLOs, marketed worldwide.
CLOs survived the Great Recession relatively unscathed, so they have been popular again recently. This month, however, these bundles have seen violent price swings and have been among the worst-performing investments.
When junk bonds come under pressure, as they are now, funds and other investors try to sell them, sparking market swings, which create even greater uncertainty. Those pressures also discourage lenders from putting additional money into new high-risk bonds, which makes it harder for troubled companies to roll over their loans.
The teetering junk bond market also can make investors leery of bonds in general, causing the credit market to tighten or freeze. That could set off a domino effect of defaults, bankruptcies, lost jobs, and economic turmoil.
TREND FORECAST: The “Greatest Depression” will trigger a wave of defaults larger than that of the Great Recession. Bottom-of-the-barrel junk bonds, those rated B3 or lower, made up 38 percent of the junk bond market last July, compared with 22 percent in 2008, according to Moody’s Analytics.
“Investors probably will be surprised at the extent of their losses,” said Oleg Melentyev, a Bank of America investment strategist. He estimates 29 percent of junk loans will fail when credit tightens again, compared to about 20 percent during the Great Recession; and that investors will recover only about 50 cents on the dollar against 58 cents in 2007 through 2009.
Going Down Hard
Not only are junk bonds are in trouble, Hilton Worldwide Holdings, for example, opened a $2.6-billion line of credit last June. It was valued at 100 cents on the dollar at the end of February and now sits at 73 cents.
Cirque du Soleil owes $700 million; Moody’s now rates the loans as “in, or very near, default” after the company, which employs 4,000 people, halted it Las Vegas shows.
Still, some businesses are willing to wade deeper into the bond market.
The Disney Co. hopes to raise as much as $6 billion for “general corporate purposes” by issuing bonds in amounts from $175 million to $500 million and paying interest ranging from 3.35 percent to 4.70 percent.
Whether investors will back the full bond offering while Disney projects short-term losses of at least $500 million during the virus crisis remains to be seen.
TRENDPOST: The debt bubble is bursting, and no amount of cheap money pumped in by the Fed will solve the problem since it was the cheap money binge that inflated the $250 trillion debt bubble, which is now ready to explode.
In the Trends Journal, we have been constantly warning of the massive debt dangers, and now those warnings have come to pass.
