Corporate & Securities Law

The bond markets are getting riskier according to a recent Wall Street Journal article.  Bond markets are growing riskier as investors seeking steady returns bid up prices and ignore some early warning signs similar to those that flashed during the credit bubble. 

In mid-September, prices on high-yield, or junk, bonds hit their highest level since 2007, nearly double their lows of the credit crisis.  Nine months into the year, companies have sold $172 billion in junk bonds, already an annual record.

To some extent, the bull case for junk bonds is based on a declining rate of corporate defaults and a belief that, as long as the economy doesn't relapse into recession, default rates will continue to decline.  The financial crisis purged many weak borrowers from the system, and corporate balance sheets are generally stronger today than before the crisis.  However, a double-dip recession could hurt another, albeit smaller, wave of borrowers.

Importantly, the demand for bonds has allowed some of the riskiest borrowers to sell bonds with fewer protections for investors.  Those provisions, or covenants, prevent companies from taking actions that would hurt bondholders and would protect investors if companies are sold.

Some have watered down covenants, which are supposed to protect investors if a company is sold and prevent companies from loading on too much other debt or paying out their cash, which would cause a drop in value of the bonds or make it less likely the bonds they hold would get paid off.

Fifty-seven percent of junk-bond issuers had less-stringent covenants than their previous junk deals. Just one deal had stronger covenants for investors.  Some 41% of the deals had the same covenants. A decline in investor rights was a marker of a rising bubble in the years leading up to the market collapse of 2008.  Just like then, investors are scrambling to invest in deals, some of which are completed in a day in what are called on Wall Street "drive-by" offerings.

For example, when Tenet Healthcare Corp. sold $600 million in junk bonds in August, investors had fewer protections than they had in previous Tenet bonds.  The bond deal from the Dallas hospital operator and health-care company lacked an asset-sale covenant, which would have forced the company to use proceeds from the sale of a material asset to buy another asset, make capital expenditures or repay bond investors.  Those covenants also prevent companies from using cash from asset sales to pay salaries.  The recent Tenet deal also lacks a restricted payment covenant, which blocks dividend payouts.

Two junk bonds issued by Chesapeake Energy Corp., an Oklahoma City company that is the second-largest U.S. natural-gas producer, illustrate how new bonds are being sold. In an August sale, Chesapeake sold $2 billion worth of junk bonds maturing in 8 and 10 years.  Chesapeake is using the bond sales to pay down existing debt and for general corporate use.

According to Covenant Review, neither bond offers a "change-of-control" covenant. When that protection is included and a company is sold, bond-holders can sell back their bonds at 101% of par value.  In an August 9 report to clients, Covenant Review said Chesapeake "is yet another issuer trying to take advantage of a hot market by quickly passing off a materially worse covenant package."

SNSFE attorneys continue to monitor the bond markets as they get riskier.  Those with information should feel free to contact attorneys at SNSFE.

Source:  The Wall Street Journal