Three cents. Two cents. Even a mere 0.125 cents on the dollar.
More and more, these are the kinds of scraps that bondholders are fighting over as companies go belly up.
Bankruptcy filings are surging due to the economic fallout of Covid-19, and many lenders are coming to the realization that their claims are almost completely worthless. Instead of recouping, say, 40 cents for every dollar owed, as has been the norm for years, unsecured creditors now face the unenviable prospect of walking away with just pennies -- if that.
While few could have foreseen the pandemic’s toll on the economy, the depth of investors’ pain from corporate distress was all too predictable. Desperate to generate higher returns during a decade of rock-bottom interest rates, money managers bargained away legal protections, accepted ever-widening loopholes, and turned a blind eye to questionable earnings projections. Corporations, for their part, took full advantage and gorged on astronomical amounts of debt that many now cannot repay or refinance.
It’s a stark reminder of the long-lasting repercussions of the Federal Reserve’s unprecedented easy-money policies. Ultralow rates helped risky companies sell bonds with fewer safeguards, which creditors seeking higher returns were happy to accept. Now, amid a new bout of economic pain, the effects of those policies are coming to bear.
Debt issued by the owner of Men’s Wearhouse, which filed for court protection in August, traded this month for less than 2 cents on the dollar. When J.C. Penney Co. went bankrupt, an auction held for holders of default protection found the retailer’s lowest-priced debt was worth just 0.125 cents on the dollar. For Neiman Marcus Group Inc., that figure was 3 cents.
CDS Sadness
Credit default swap auctions portend steeper-than-usual losses
Sources: Creditex and Markit
Note: data limited to U.S. companies
The loose lending terms that investors have agreed to mean that by the time corporations file for bankruptcy now, they’ve often exhausted their options for fixing their debt loads out of court. They’ve swapped their old notes for new ones, often borrowing against even more of their assets in the process. Some have taken brand names, trademarks, and even whole businesses out of the reach of existing creditors and borrowed against those too. While creditors always do worse in economic downturns than in better times, in previous downturns, lenders had more power to press companies into bankruptcy sooner, stemming some of their losses.
The pandemic is upending industries like retail and energy, making it unclear how much assets like stores and oil wells will be worth in the future. The underlying problem for many companies, though, is that they have astronomical levels of debt after borrowing with abandon over the previous decade, then topping up with more to get them through the pandemic.
For bondholders, the kind of liabilities that companies have added makes the problem worse. Loans have been a particularly cheap form of debt for many companies over the last decade. Those borrowings are usually secured by assets, leaving many corporations with more secured debt than they’ve had historically. That means that unsecured bondholders end up with less when borrowers go broke.
“We’ll see companies gradually hitting the wall -- it’s just a question of when and how fast,” said Dan Zwirn, founder of Arena Investors, a $1.7 billion investment firm with an emphasis on credit. “There’s just going to be way more downside.”
Record Lows
The recent low values for bonds in credit derivatives auctions signal that in future bankruptcies owners of unsecured bonds, not to mention loans, may suffer a bigger hit than usual, according to research from Barclays Plc. The median value for companies’ cheapest debt in credit derivatives auctions this year is just 3.5 cents on the dollar, a record low and far below the 23.4 cent median for 2005 through 2019.
The value of a company’s bonds in an auction for credit derivatives payouts doesn’t necessarily equal how much money bondholders will actually recover when a bankruptcy is complete. But lower auction values do tend to correlate to lower recoveries, according to Barclays. Lower market values also reflect investor concerns.
The auctions represent the value of a company’s cheapest unsecured bond, although usually most of a borrower’s unsecured notes trade around the same price in bankruptcy, according to Barclays. When a company defaults or files for bankruptcy, an investor that bought a credit default swap receives a payout equal to 100 cents on the dollar minus the auction value of the cheapest-to-deliver security.
Loan Pain
It’s not just bond investors that will suffer from low recoveries. Amid the pandemic downturn, loan investors could find themselves losing 40 to 45 cents on the dollar, compared with historical averages of 30 to 35 cents, according to Barclays.
One factor that is hurting money managers is the erosion of investor protections known as covenants, as more and more high yield and leveraged loan deals are covenant-lite, meaning they feature minimal such safeguards. When corporations had more restrictive covenants, borrowers had less room to fix their debt outside of court, sending them into bankruptcy closer to the first sign of trouble.Now companies have more leeway to seek extra financing when they’re in trouble, and to give lenders providing additional funds the right to jump to the front of the line if the company does go bankrupt.
“Covenant-lite paper usually means by the time you get back to the table with the borrower, the house is on fire,” said Sanjeev Khemlani, a senior managing director at FTI Consulting. “All of that extra time you had before, that’s just gone away.”
Oaktree Deal Crushed a Leveraged Loan and Exposed Market’s Woes
Investors that bought a J. Crew Group Inc. term loan at par back in 2014 may have thought they were making a relatively safe bet, since it was secured debt. When the company started struggling a few years later, it moved intellectual property including its brand name into a new entity, a move enabled by relatively loose covenants.
The company then exchanged some of its existing bonds for new notes secured by the intellectual property as well as preferred stock and equity in its parent company, as part of a broad restructuring. Loan investors ended up suffering: after the company filed for bankruptcy in May, the 2014 obligation was worth less than 50 cents on the dollar, according to Bloomberg loan valuation estimates. (J. Crew exited bankruptcy in September.)
FTI’s Khemlani, who advises lenders with senior claims on borrowers’ assets, said investors should make an effort to “put some teeth” into their agreements with borrowers now as they fall into distress, regaining some lost protection.
In addition to shifting assets, companies have also been doing more distressed exchanges in recent years, where troubled corporations offer creditors new, debt that often ranks higher in the repayment pecking order in exchange for relief like lower principal or later maturities or both. Creditors that participate can stem their losses in the event of a bankruptcy, but investors that sit the deal out can end up worse off.
The popularity of distressed exchanges has also contributed to a general rise in secured debt in companies’ capital structures. That means that more investors -- holders of loans and secured bonds -- are fighting for the same scraps when a company files for bankruptcy. Almost 20% of the debt in the U.S. high-yield bond market is now in some way secured, according to Barclays, versus just 6% in 2000. The number of businesses that had taken out just loans and no other form of debt almost doubled between 2013 and 2017, according to JPMorgan Chase & Co. data.
US stocks suffered their worst selloff in weeks Monday as Wall Street grappled with a nationwide surge in coronavirus infections and continued doubts about another stimulus package.
The Dow Jones industrial average sank as much as 965.41 points, or 3.4 percent, to 27,370.16 in early trading after the US recorded more than 83,000 new COVID-19 cases on both Friday and Saturday — breaking the previous mid-July peak of about 77,000.
The blue-chip index recovered to close down 650.19 points, but it was still the worst day since at least Sept. 3, when it shed about 1,025 points before closing down 807.77 points. The S&P 500 similarly dropped as much as 2.9 percent before clawing back losses to close down 1.9 percent to start the final week of trading before the presidential election. The tech-heavy Nasdaq lost 1.6 percent.
“The double whammy of a stalled stimulus bill and new highs in cases is a harsh reminder of the many worries that are still out there,” said Ryan Detrick, chief market strategist for LPL Financial.
Investors appeared unnerved by the new resurgence in the virus — which could do even more damage during the colder fall and winter months — despite news that British drugmaker AstraZeneca’s experimental vaccine provoked an immune response.
Recent spikes in infections have led to renewed lockdown measures in European countries such as the UK and Italy, raising further questions about the pandemic’s economic harm. But White House chief of staff Mark Meadows told CNN on Sunday that the US is “not going to control the pandemic” because COVID-19 is “a contagious virus just like the flu.”
“It is becoming difficult for investors to keep a cool head,” said Milan Cutkovic, market analyst at Axi. “Whether there will be another major sell-off or a continuation of the stock market rally will likely depend on how quickly governments and central banks will react to the latest developments in the COVID-19 pandemic.”
It also looks increasingly unlikely that Congress and the Trump administration will reach a deal on a new stimulus bill to blunt the virus’s economic impact before the Nov. 3 election. Economists say more spending is needed to continue the nation’s recovery from the economic collapse that the pandemic caused in the spring.
House Speaker Nancy Pelosi (D-Calif.) said Sunday that she’s not giving up hope for an agreement, but Senate Majority Leader Mitch McConnell (R-Ky.) has reportedly opposed a large-scale package.
“I think that as we headed to the election, there was a set of fears” about a surge in COVID infections along with a lack of stimulus, Jim Paulsen, chief investment strategist at the Leuthold Group, told The Post. “And there’s just enough news to bring them all together at relatively high market levels.”
“A stimulus package would have been a nice distraction and seen households and businesses through to the new year when everything will be much clearer,” Craig Erlam, senior market analyst at OANDA, said in a commentary. “Alas, investors have far too much faith in lawmakers on Capitol Hill.”
In London...
Creditors Finally Wake Up To
An Apocalyptic Reality: Bond
Losses As High As 99%
26 October, 2020
Back in March 2016, we published an article explaining how the coming default cycle - when it finally hits - would be different: it would be marked by record low recovery rates. While there were many reasons for that, three stood out: i) the disconnect between fundamentals and asset prices thanks to the Fed's constant manipulation of markets, ii) the record layering of debt upon debt, much of it secured, and iii) the years of covenant-lite deals that stripped most if not all creditor protections over the past decade (something which as we noted recently has resulted in bitter creditor fights and a "civil war" involving some of the most prominent names in investing).
Fast forward to today when Bloomberg picks up on what we said almost five years ago, and in "Bond Defaults Deliver 99% Losses in New Era of U.S. Bankruptcies" writes that more and more, bondholders are fighting over recoveries as low as 1 cent. The story should be familiar as we have discussed in constantly in recent months: in a post-covid world, where bankruptcy filings are surging, many lenders are coming to the realization that their claims are almost completely worthless, just as we warned would happen in 2016.
Instead of recouping, say, 40 cents for every dollar owed, as has been the norm for years, unsecured creditors now face the unenviable prospect of walking away with just pennies -- if that.
Several stark examples of this epic collapse in recoveries is the current price of a handful of retailers' bonds. Men’s Wearhouse, which filed in August, traded this month for less than 2 cents on the dollar. When J.C. Penney Co. went bankrupt, an auction held for holders of default protection found the retailer’s lowest-priced debt was worth just 0.125 cents on the dollar. For Neiman Marcus that figure was 3 cents. Indeed, as the following chart of median CDS auctions finds record low recoveries for bondholders (which of course is great news for all those who bought the CDS).
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