MARKETS
Borrowing Binge Reaches Riskiest Companies
Demand for corporate debt has offered lifelines to struggling firms that can borrow at interest rates once reserved for the safest type of bonds
Until recently, mainstream debt investors were unwilling to lend to USA Today publisher Gannett because of shrinking subscription and advertising revenue.
Investors’ near-insatiable demand for even the riskiest corporate debt is fueling a Wall Street lending boom, offering lifelines for struggling companies even as the coronavirus pandemic still drags on the economy.
Companies such as hospital operator Community Health Systems Inc. and newspaper publisher Gannett Co. Inc. 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. (my note, CCC default probabilities are pretty high - cumulative default rate for CCC rated companies for the 10yr period of 2009 - 2019 was 49.09%, about 5%/yr vs. a BBB- cumulative default rate for that period of 0.6%, BBB is actually higher at 1.06%, but using the lowest investment grade rating before a credit becomes high yield/junk as a comparison, long term historical recovery rate is around 60 cents on the dollar and declining over time as assets become less tangible, so the "expected loss if you were to invest in the CCC cohort would be around 4.9% x 60% or a shade below 3% which means if you are buying at 4% rounded from 3.97% you expect to make 1% basically, net of losses, investing in all CCC rated universe) Despite the onslaught of new bonds, riskier companies can now borrow at interest rates once reserved for the safest type of debt.
As of Friday, the average yield for bonds in the ICE BofA US High Yield Index—a group that includes embattled retailers and fracking companies—was just 3.97%. By comparison, the yield on the 10-year U.S. Treasury note, which carries essentially no default risk, was as high as 3.23% less than three years ago. The 10-year Treasury yielded around 1.2% Friday.
“At a high level, you have a meaningful imbalance between supply and demand,” said David Knutson, head of credit research for the Americas at Schroders, the U.K. asset management firm.
“The demand exceeds the supply for bonds.”
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 has revealed a winter slowdown in the recovery.
Debt investors are hardly alone in their enthusiasm. Investors across a range of asset classes have poured money into risky wagers, even as the frenzy around videogame company GameStop Corp. and other popular stocks for individuals calms. Commodities such as oil and copper have surged lately, and more than $58 billion went into mutual and exchange-traded funds tracking global stocks during the week ended Wednesday, the largest such inflow on record, according to a Bank of America analysis of data from EPFR Global.
Investors’ optimism rests largely on the idea that current economic challenges aren’t normal and can be resolved quickly once coronavirus vaccines are more widely distributed. The combined efforts of the Federal Reserve and Congress have also helped by depressing benchmark interest rates and pumping trillions of dollars into the economy,
Investors this week will weigh data on January retail sales and industrial production, figures that will offer the latest gauge of U.S. economic activity. The latest flurry of earnings results from bellwether companies like Walmart Inc. will also be in focus, as will any progress in Washington toward a new coronavirus relief package. Congress has also scheduled a hearing on the GameStop volatility for Thursday.
Strong demand from investors for riskier debt can create a positive feedback loop for companies. Struggling ones can refinance their debt, holding down the overall corporate default rate. That then further boosts investors’ demand.
In recent weeks, three businesses have financed dividends to private shareholders by issuing so-called 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.
Regulators have previously warned banks and investors against providing debt to companies in excess of six times earnings before interest, taxes, depreciation and amortization, or Ebitda. Still, about 53% of mergers and acquisitions paid for with below investment-grade loans in January exceeded that guardrail, the highest ratio since August 2017, according to data provider LevFin Insights.
One company that is capitalized on current market conditions is Community Health Systems, one of the country’s largest for-profit hospital operators.
For years, Community Health has struggled with the challenges of serving low-density, lower-income populations and the fallout from a 2014 acquisition, which handed it a portfolio of struggling hospitals and a burdensome debt load. Even after arresting a decline in earnings, the company was positioned last year to burn about $200 million to $250 million of cash annually in a normal environment, said Eric Axon, a senior analyst at the research firm CreditSights.
Yet investors have snapped up a series of secured bond sales from the hospital chain during the past two months, enabling the company to both substantially reduce its interest expense and pay down bonds due in 2023 and 2024. In effect, the company seized on the strong market rally “to deal with problems that almost looked unsolvable six months ago,” Mr. Axon said.
The surge of new money is also rewarding some hedge-fund managers who specialize in lending to companies in financial stress. Gannett, the country’s largest newspaper chain,
borrowed a $1 billion loan in January with a 7.75% interest rate to repay an existing loan with an 11.5% rate, boosting its stock price and benefiting Apollo Global Management LLC, one of its largest investors.
Gannett was able to “take advantage of the current credit market and refinance into a widely syndicated public loan at significantly better terms,” Chief Executive Officer Mike Reed said in an email.
Mainstream debt investors were unwilling to lend to Gannett until recently because of its shrinking subscription and advertising revenue, so the company relied on hedge funds like Apollo for capital. But last month—as risk appetite rose and after Apollo exchanged a loan it had made into bonds that convert into Gannett stock—roughly 35 debt funds lent to Gannett at the lower rate, people familiar with the matter said. The company’s stock has jumped about 80% since Jan. 1 and its annual debt expense has dropped by about $90 million during the past year, a company spokeswoman said.
Some investors and analysts say there are legitimate reasons why the market should be as open as it is now, beyond optimism about the near-term economic outlook.
Among those factors are the nearly 40-year decline in U.S. Treasury yields, which has fueled demand for higher-yielding assets. Some are also hopeful that Congress and the Federal Reserve could be nearly as aggressive in fighting future recessions as they were the most recent one.
Still, some analysts aren’t convinced that lower-rated debt is less risky than in the past, arguing that struggling companies will eventually default on their debt when interest rates rise or their own problems worsen.
“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.”
—Amrith Ramkumar contributed to this article.
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