The Great Unwind Has Begun, Bankruptcies Soar

The junk-bond market lost money in July. Not a lot, 0.62%. But it did so after having already lost money in June. It was the third losing month so far this year, despite their “high” coupon payments that make these bonds look so juicy to yield-desperate fund managers.

Until recently, they were superb investments, riding up the credit boom. Junk-bond guru Marty Fridson, CIO of Lehmann Livian Fridson Advisors, explained in a note for S&P Capital IQ LCD (behind paywall; some reports are at LCD’s free highyieldbond.com):

Strategists frequently take the easy way out in their year-ahead outlooks by predicting that the high-yield market will “earn the coupon.” At this stage, 2015 is shaping up as another year that makes false prophets of those who assumed, in the face of overwhelming experience to the contrary, that it would be free of both positive and negative shocks.

But it’s just the timid beginning.

The Fed hasn’t even raised interest rates yet, and the largest credit bubble in history continues to inflate. But it has begun to hiss hot air at the margins where the riskiest junk bonds, rated CCC or below, have plunged in value and where average yields have soared from a ludicrous low of 8% a year ago to over 13% now. That rout is far from over.

No matter how terrible and obvious the risks, fund managers, driven to near insanity by the Fed’s zero-interest-rate policy, held their noses and closed their eyes and picked up the worst junk, thus continuing to fund over-leveraged, money-losing, cash-flow negative companies that should have been restructured or liquidated years ago.

These investors provided the new money that kept the charade going and bailed out the old money. Energy companies are at the center. But it’s spreading beyond them. And all this debt on their balance sheets is now coming home to roost, under the supervision of the courts.

A few weeks ago, Fitch Ratings raised its high-yield default outlook for 2015 from a range of 1.5%-2% to a range of 2.5%-3%. For energy companies, it expected the default rate to jump to “the 6%-7% range.” The overall default rate would increase further in 2016, but to soothe our ragged nerves, it added that it would still be “well below peak levels seen during the Financial Crisis.”

Already, corporate Chapter 11 bankruptcy filings in July have soared 77% year-over-year, to 637 filings, the most in nearly three years, the Wall Street Journal reported, based on data from Epiq Systems

OK, April 2014, an otherwise super-calm year, was bigger, but that was due to one company that filed 71 petitions: Energy Future Holdings, former TXU, the largest utility in Texas that had become the largest LBO on the eve of the Financial Crisis.

The largest bankruptcies in July, according to Bankruptcy Data, included:

  • Coal producer and mining operator Alpha Natural Resources, with $10.7 billion in pre-petition assets.
  • Coal producer and exporter Walter Energy with $5.4 billion in pre-petition assets. Both followed the bankruptcy filing of Patriot Coal in May, its second in three years.
  • Oil and gas producer Sabine Oil & Gas, with $ 2.4 billion in pre-petition assets.
  • Oil and gas producer Milagro Oil & Gas, with $390 million in pre-petition assets.

The rest in July were smaller.

A word about the harmonious relationship between coal and natural gas: Coal as a fuel for electricity generation has been ravaged for years by the low price of natural gas and by a technological innovation, the rise of highly efficient combined-cycle natural-gas turbines that can be used for base and peak power. At the current low price of natural gas, prevailing more or less since the Financial Crisis, coal doesn’t have a chance.

Neither does natural gas. The price has been so ruinously low that specialized natural gas producers are approaching bankruptcy or have already filed [read… It’s Happening: Debt Is Tearing up the Fracking Revolution].

But it wasn’t all about energy. According to Fitch, in the first half of the year, companies in energy, metals (another brutalized sector), and mining accounted for 57% of the defaults. The rest were all over the place.

In July, that included one of Colony Realty Partners’ commercial real-estate investment funds which owns, according to Dow Jones’ Bankruptcy News, “six office buildings and 26 industrial buildings located near such metropolitan areas as Boston, Chicago and Washington, D.C.”

Plus grocery chain A&P (it’s second time in Chapter 11), taco chain restaurant Z’Tejas, grain transporter Trans Coastal Supply, and Uber loser New York City taxi mogul Evgeny Freidman, who’d asked the city for a bailout, claiming he was too big to fail, and when they refused, according to the New York Times, “he filed a petition to put many of his taxi medallion-owning companies into bankruptcy.”

And there were a slew of others.

Bankruptcy lawyers and restructuring gurus have been licking their chops. But the expected tsunami of new business hasn’t materialized yet. There were “pockets of business but still feels very lumpy,” Shaunna Jones, bankruptcy lawyer at Willkie Farr & Gallagher, told the Wall Street Journal. She’s still waiting for the really good times: “On the ground, it doesn’t feel like things have markedly or permanently picked up.”

But this is just the timid beginning of the Great Unwind. There is still too much money sloshing around, and most junk-rated companies can still get funding from desperate fund managers and lenders. They continue to cover losses, negative cash-flows, and debt payments with newly borrowed money. They won’t default until the spigot gets turned off. And one by one, these spigots are now slowly getting turned off.

Private Equity is a big force in the investment scene. It’s considered the “smart money” because of its acumen, insider knowledge, and ability to time the markets to profitably exit long-term illiquid investments. But recently, they’ve been doing something else. Read… Smart Money Dumps Assets at Record Pace, But Who the Heck Is Borrowing and Buying Like There’s No Tomorrow?

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