The Fed Triggered an Insatiable Demand for the Riskiest Corporate Debt
Junk Bond Borrowing Binge
Companies such as hospital operator Community Health Systems Inc. and newspaper publisher Gannett Co. have issued a record $139 billion of bonds and loans with below- investment-grade ratings from the start of the year through Feb. 10, according to LCD, a unit of S&P Global Market Intelligence. More than $13 billion of that debt had ratings triple-C or lower—the riskiest tier save for outright default—about twice the previous record pace.
Despite the onslaught of new bonds, riskier companies can now borrow at interest rates once reserved for the safest type of debt.
The most striking aspect of the current lending boom is its timing. Typically, it can take years after recessions for the market to reach its present level of exuberance, analysts said. In this case, it has taken less than 12 months and has arrived just as economic data have revealed a winter slowdown in the recovery.
In recent weeks, three businesses have financed dividends to private shareholders by issuing PIK toggle notes—bonds that give the issuer flexibility to pay interest in additional bonds rather than cash. Such deals are hallmarks of hot credit markets, rising to prominence in the years leading up to the 2008-2009 financial crisis.
“The way the market is viewing this right now is basically saying, if all these triple-Cs can access funding, they’re not going to default,” said Oleg Melentyev, head of U.S. high-yield strategy at BofA Global Research.
The problem, he said, is investors are “hoping that this argument will work longer than it probably will.”
Investors are plowing into garbage just above default.
A: Fed Triggered Mania
There Are No Hawks on the Fed, Only Ostriches
On January 15, I commented There Are No Hawks on the Fed, Only Ostriches
Not to worry, “We’ll let the world know,” when we spot inflation says Powell who cannot see the big pink elephant standing right on the Fed's table.
The immense asset bubbles in the stock market, housing market, and bond market, provide ample evidence of inflation.
Instead, the Fed and most economists view the CPI, a fatally flawed measure, as representative of inflation.
The result of their head in the sand approach is three consecutive asset bubbles in 20 years, with increasing amplitude.
Fed's New Facility Will Buy Junk Bonds With 7-1 Leverage
On June 15, 2020 I noted Fed's New Facility Will Buy Junk Bonds With 7-1 Leverage
With highly questionable legality on top of a 100% certain moral hazard, here are the details of the Fed's new Secondary Market Corporate Credit Facility
Credit Facility Terms
- The issuer was rated at least BBB-/Baa3 as of March 22, 2020, by a major nationally recognized statistical rating organization (“NRSRO”). If rated by multiple major NRSROs, the issuer must be rated at least BBB-/Baa3 by two or more NRSROs as of March 22, 2020.
- An issuer that was rated at least BBB-/Baa3 as of March 22, 2020, but was subsequently downgraded, must be rated at least BB-/Ba3 as of the date on which the Facility makes a purchase. If rated by multiple major NRSROs, such an issuer must be rated at least BB-/Ba3 by two or more NRSROs at the time the Facility makes a purchase.
- The issuer has not received specific support pursuant to the CARES Act or any subsequent federal legislation and must satisfy the conflicts of interest requirements of section 4019 of the CARES Act.
- The Facility will leverage the Treasury equity at 10 to 1 when acquiring corporate bonds of issuers that are investment grade at the time of purchase.
- The Facility will leverage its equity at 7 to 1 when acquiring corporate bonds of issuers that are rated below investment grade at the time of purchase and in a range between 3 to 1 and 7 to 1, depending on risk, when acquiring any other type of eligible asset.
Not Remotely Legal
Not only is the facility illegal, it's a moral hazard asset prices support system that keeps zombie corporations alive.