Junk Debt Party Now, Apocalypse Later

Barron’s assuaged our fears about junk bonds. “High yield is likely to be relatively safe and offer decent yields for the next year or two.” A year or two? And then what? Ah… “But risks loom as the credit cycle stretches out and the long-expected rise in rates materializes.”

Everyone gets out in time. That’s the idea. Everyone, all at once. With no buyers at the other end because everyone is getting out, rather than in. But Barron’s was right, even if the timing doesn’t work out: whatever mayhem awaits us in the future, at the moment we’re having fun.

Possibly the most fun ever:

Charter Communications’ offer to buy the much larger Time Warner Cable for a red-hot $78.7 billion comes on top of its previously announced but now amended deal to buy Bright House Networks for $10.4 billion. But that deal suddenly requires an additional $2 billion in debt, as Charter disclosed in an SEC filing. In order to pull both deals off, Charter would likely have to issue over $25 billion in new debt.

Charter has already lined up some of its ducks in a row. This is the greatest credit bubble in history, and money for deals is sloshing through the system in utter abundance. According to Bloomberg, Bank of America, Credit Suisse, Goldman Sachs, and UBS have committed to provide $31 billion to fund the purchase.

Thing is, Charter is junk-rated. Moody’s rates it Ba3 – three levels below investment grade. And these two deals would turn Charter into one of the largest junk-debt issuers ever, or possibly, when it’s all said and done, the largest one.

The largest-ever junk-debt deal so far was the leveraged buyout of TXU, the biggest electric utility in Texas, masterminded by KKR, TPG Capital, and Goldman Sachs, at the very tippy top of the prior bubble in October 2007. The “smart money” made a bet: TXU, which relied heavily on coal-fired power generation, would gain a competitive advantage over the gas-fired power plants of its competitors as the price of natural gas would soar because the US would run out of gas and would have to import much of it as LNG at high international prices.

But as the US fracking boom took off, the price of natural gas crashed, the hoped-for cost advantage of coal over gas disappeared, and the mountain of junk-rated debt crushed TXU. In April a year ago, Energy Future Holdings, as TXU has been renamed, declared bankruptcy “to create a sustainable capital structure to better support our high-performing operations.”

Below-investment-grade debt is called “junk” for a reason. If the hoped-for synergies and pricing bets and imaginary growth trajectories don’t pan out in these deals – and they rarely if ever do – then all heck breaks lose down the road. But not now. TXU’s road to bankruptcy took seven years.

These glorious junk-rated mega deals are only possible in full-blown credit bubbles. As they say in banking: bad deals are made in good times.

So Charter is joining good company of mega junk-debt issuers. Charter’s bet is that these acquisitions will almost quadruple its number of cable subscribers who will then take care of the mountain of debt, and it’s hoping that cable-cutting doesn’t become a national passion.

TWC, which Moody’s rates at the lower end of investment grade, already has $23 billion in gross debt. But since it is being acquired by a junk-rated company with much more leverage, Moody’s put TWC’s debt on review for a downgrade:

The review for downgrade reflects its intention to merge with a lower-rated and more leveraged entity, which given the financing plans which include a significant debt component, will lead to deterioration in the newly combined TWC, Charter and Bright House’s balance sheet strength and credit metrics to a level not consistent with a family investment grade rating.

We estimate that the deal could leave the combined entity with a debt burden (gross unadjusted debt) in excess of $60 billion and pro-forma debt-to-EBITDA (incorporating Moody’s standard adjustments) of approximately 4.5x, compared to TWC’s current outstanding gross debt of $23 billion and adjusted leverage of 3.0x.

Charter granted existing TWC bondholders security, thereby increasing the proportion of secured debt in the capital structure. Which made Moody’s nervous. It now “anticipates that the review will result in a multi-notch downgrade of TWC’s long-term debt ratings below investment grade status.” A downgrade to junk.

Standard & Poor’s also placed TWC’s senior unsecured debt on CreditWatch with negative implications.

And here, according to Bloomberg, is what happened next:

Time Warner’s bonds jumped by the most in more than a year after Charter announced its plan to purchase the company. Time Warner’s $1.25 billion of 4.5 percent notes coming due in September 2042 gained 9.5 cents to 88.3 cents on the dollar to yield 5.5 percent…. Its $1.5 billion of 7.3 percent bonds maturing in July 2038 posted the biggest gain, with a 11.7 cent increase to 114.3 cents….

Let the good times roll. All asset prices will rise forever. Money is still nearly free. Be happy, don’t worry. Thank you halleluiah, Fed, for these wondrous times. The apocalypse has to wait.

Alas, the good times have been rolling for a very long time, and many promises to pay are now unsustainable. This is where the vast US municipal bond market gets very messy. Read…  Schwab Warns on Munis, those “Affected by Pensions” Are Toxic

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