Retail Debt Debacles

The retail sector has replaced the oil sector in a sense, and not in a good way. It is the sector that is most likely to see a large surge in bankruptcies this year. Junk bonds issued by retailers are performing dismally, and within the group the bonds of companies that were subject to leveraged buyouts by private equity firms seem to be doing the worst (a function of their outsized debt loads). Here is a chart showing the y-t-d performance of a number of these bonds as of the end of March:

 

Returns of several of the worst performing junk bonds issued by retailers in Q1 2017. This is rather impressive value destruction for a single quarter – click to enlarge.

 

Note the stand-out Neiman Marcus, a luxury apparel retailer, the bonds of which have been in free-fall this year. The company was bought out in an LBO and was saddled with a mountain of debt in the process. Investors buying this debt have now come to regret their purchases, particularly as it is debt of the “creative” kind.

Investor demand for junk bonds continues to be brisk, with inflows from retail investors said to be particularly strong. As we have pointed out on previous occasions, this surge in demand has resulted in creditors accepting ever softer loan covenants.

A long period of extremely low interest rates not only leads to a pronounced distortion of relative prices and the associated malinvestment of capital, it also tends to make a growing number of debtors increasingly vulnerable to rising rates and other disruptions. Over time, the number of companies forced to regularly roll over debt if they want to remain among the quick will inevitably increase.

These companies then depend on high investor confidence, which is now faltering in the retail sector. The out look seems appropriately grim: Fitch expects the default rate in the sector to spike to 9% this year.

 

Yields on junk bonds issued by retailers have begun to diverge rather noticeably from yields on the broader junk bond universe this year – which is reminiscent of oil sector junk bonds in 2014 – click to enlarge.

 

Ponzi Instruments

One of the innovations created in order to exploit the mindless yield-chasing by investors are so-called PIK toggle bonds (PIK= payment in kind), which essentially represent Ponzi finance instruments.

The term “Ponzi finance” was coined by post-Keynesian economist Hyman Minsky. We think his financial instability hypothesis is descriptive rather than explanatory, but we don’t want to focus on Minsky’s theory. Still, it is at least worth noting in passing that he ultimately argued in favor of even more government intervention, so he basically just recast the old “market failure” fairy tale.

 

Left: famous early 1920s fraudster Charles Ponzi at the height of his career, shortly befor his actions brought down six banks in the Boston area and impoverished thousands of gullible investors. Right: post-Keynesian economist Hyman Minsky, who used Ponzi’s name to describe a certain type of borrower in the framework of his “financial instability hypothesis”.

Photo via Boston Public Library / Levy Economics Institute of Bard College

 

Anyway, Minsky differentiated between three types of borrowers one can observe in the “stable” period (i.e., in the boom phase): 1. hedge borrowers, who are able to meet all their debt obligations from cash flows; 2. speculative borrowers, able to pay interest out of their cash flows, but unable to meet redemptions of principal without issuing new debt; and 3. “Ponzi borrowers”, who aren’t even able to meet interest payments on their debt without issuing more debt.

In this sense, PIK toggle bonds are clearly instruments of Ponzi finance. Issuance of PIK bonds briefly stalled in 2015, presumably because concerns over China’s declining foreign exchange reserves and rising stock market volatility spooked investors. It recovered with a vengeance in 2016:

 

In 2016 PIK toggle bond issuance was almost back at the record set in 2014 – click to enlarge.

 

As their name indicates, these bonds allow issuers to choose whether they want to pay interest in cash, or by simply issuing more of the same bonds to bondholders. Once the second option is chosen, one can be fairly certain that the issuer is in trouble or fears he soon will be, and is scrambling to preserve short term liquidity. And that is precisely what Neiman Marcus has just done. As Marketwatch informs us:

 

“A rolling loan gathers no loss. That appears to be the adage guiding upscale department-store chain Neiman Marcus, which has opted to make the coming interest payments on its high-yield bonds by issuing more debt, instead of burning through cash. The company said it was electing the payment-in-kind (PIK) option on its $600 million in 8.75% notes due to mature in 2021 for the coming six-month coupon period through Oct. 14, according to a filing with the Securities and Exchange Commission. The move is aimed at enhancing its liquidity, the Dallas-based company said. It will pay PIK interest at a rate of 9.50% for the interest period, which started on April 15. The current yield on the benchmark 10-year Treasury is just 2.20%.

Neiman had $105.8 million in cash and cash equivalents on hand as of April 1, and has $423.2 million of unused borrowing available under its $900 million asset-based revolving credit facility, according to the filing. The bonds in question were quoted at 56.75 cents on the dollar on Wednesday, according to MarketAxess. Like many retailers, Neiman has struggled with changes impacting the industry, from weak mall traffic to evolving consumer behavior to intensifying competition from juggernaut Amazon.com Inc. In February, S&P Global Ratings cut the company’s rating by three notches to CCC-plus, placing it deep into junk territory, citing a poor operating performance.

(emphasis added)

 

Perhaps Neiman Marcus serves as a kind of canary in the coal mine for the retail sector now (or at least the apparel sub-sector), but this is not the first time it has used the “toggle” function of its PIK bonds. What makes this instance stand out a bit is that it happens after a very persistent downtrend in same-store sales (five quarters in a row).

As the first chart shows, apparel chains are evidently not the only brick and mortar retailers in trouble. Moreover, if the default rate forecast by Fitch turns out to be correct, there should be a significant impact on the commercial real estate business down the road. A great many shopping malls are bound to turn out to be surplus to requirements. As an aside to this, we suspect that quite a few office towers will eventually become obsolete as well.

 

A glimpse of the future?

Photo credit: Seph Lawless

 

Clusters of Errors

In the excerpt from the Marketwatch article above it is inter alia pointed out that the company and many of its peers are “struggling with changes impacting the industry”. That almost sounds like a report on a ship that is about to capsize because its crew was surprised by inclement weather and high waves.

That is not really the case here though; these problems are not akin to a natural catastrophe. Whenever large clusters of business errors emerge in a sector of the economy, one must wonder how this is even possible (that applies to the recent problems in the energy sector as well). Are that many businessmen and investors  involved in the sector so bereft of foresight that they could not see this coming?

That seems rather unlikely; it seems far more likely that their decisions were somehow led astray. The culprit at the top of our list is the fact that in the past eight years alone, the Federal Reserve has aided and abetted the creation of ~7.35 trillion dollars in new money in addition to the 5.3 trillion dollars that existed in early 2008.

 

US broad true money supply TMS-2: when the money supply is expanded by 140% in eight years, stuff happens. It feels good at first, but illusory profits and phantom wealth always disappear down the road, one way or another – click to enlarge.

 

As we have recently discussed, money supply growth is currently falling quite rapidly – we expected growth in the broad true money supply to follow the lead of AMS, and that is now indeed happening. Without QE, money supply expansion has become relinked to growth in commercial bank credit, which is rapidly declining lately – and money supply growth has followed suit. We have to expect a further slowdown in economic activity in coming months as bubble activities begin to be liquidated (bubble activities are economic activities that would not take place without monetary pumping, as they are not really profitable).

 

Year-on-year growth rate of TMS-2 and total bank credit. The current TMS-2 growth rate of 6.12% is the lowest since October 2008, when the Fed’s various debt monetization schemes began to take off – click to enlarge.

 

Conclusion

More errors will likely be unmasked as the year progresses. Not only that, it seems we will finally find out what threshold in the money supply growth rate needs to be undercut in the post-QE era for the bubble in asset prices to burst.

PS: The fact that the companies with the biggest problems were taken over in LBOs by private equity firms is a topic we will discuss in more detail a separate post. We can tell you already though that the data indicate that in the not-too-distant future many investors are going to feel as though they have been transported to hell and eventually, even Crispin Odey’s loneliness will end.

 

Charts by: Bloomberg, St. Louis Fed

 

 
 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke

   
 

One Response to “Cracks in Ponzi-Finance Land”

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • Can Germany Be Made Great Again?
      When Germany Was Great! Ever since the start of the deliberately conceived “migrant crisis,” orchestrated by NWO elites, the news out of Germany has been, to say the least, horrific. Right before the eyes of the world, a country is being demographically destroyed through a coercive plan of mass migration.  The intended consequences of this – financial strain, widespread crime and property destruction, the breakdown of German culture – will continue to worsen if things are not...
  • Yanking the Bank of Japan’s Chain
      Mathematical Certainties Based on the simple reflection that arithmetic is more than just an abstraction, we offer a modest observation.  The social safety nets of industrialized economies, including the United States, have frayed at the edges.  Soon the safety net’s fabric will snap. This recognition is not an opinion.  Rather, it’s a matter of basic arithmetic.  The economy cannot sustain the government obligations that have been piled up upon it over the last 70...
  • Views From the Top of the Skyscraper Index
      Views From the Top of the Skyscraper Index On a warm Friday Los Angeles morning in spring of 2016, we found ourselves standing at the busy corner of Wilshire Boulevard and South Figueroa Street.  We were walking back to our office following a client wire brushing for events beyond our control.  But we had other thoughts on our mind.   Iron workers (the non-distraught variety) atop the 10 ton spire of the Wilshire Grand Center in Lost Angeles. This image is vaguely...
  • Prepare for Another Market Face Pounding
      “Better than Goldilocks” “Markets make opinions,” goes the old Wall Street adage.  Indeed, this sounds like a nifty thing to say.  But what does it really mean?   The bears discover Mrs. Locks in their bed and it seems they are less than happy. [PT]   Perhaps this means that after a long period of rising stocks prices otherwise intelligent people conceive of clever explanations for why the good times will carry on.  Moreover, if the market goes up for...
  • Bitcoin, Gold and Silver
      Precious Metals Supply and Demand Report That’s it. It’s the final straw. One of the alternative investing newsletters had a headline that screamed, “Bitcoin Is About to Soar, But You Must Act by August 1 to Get In". It was missing only the call to action “call 1-800-BIT-COIN now! That number again is 800 B.I.T..C.O.I.N.”   Bitcoin, daily. In terms of the gains recorded between the lows of 2009 and the recent highs (from less eight hundredths of a US cent per...
  • Seasonality: Will Patterns that Worked in the Past Also Work in the Future?
      Historians of the Future Every investor makes trading decisions based on what happened in the past – there is no other way. What really interests us is the future though. After all, what happens in the future ultimately determines investment success.   When in doubt, you can always try to reach the pasture...  In Human Action, Ludwig von Mises described stock market speculators as akin to “historians of the future”. This is without a doubt the most trenchant definition of...
  • Bitcoin Forked – Precious Metals Supply and Demand Report
      A Fork in the Cryptographic Road So bitcoin forked. You did not know this. Well, if you’re saving in gold perhaps not. If you’re betting in the crypto-coin casino, you knew it, bet on it, and now we assume are happily diving into your greater quantity of dollars after the fork.   Bitcoin, daily – adding the current price of BCH (the new type of Bitcoin all holders of BTC can claim at a 1:1 ratio), the gain since the “fork” amounts to roughly $1,000 at the time we...
  • What Went Wrong With the 21st Century?
      Fools and Rascals   And it’s time, time, time And it’s time, time, time It’s time, time, time that you love And it’s time, time, time… - Tom  Waits   Tom Waits rasps about time   POITOU, FRANCE – “So how much did you make last night?” “We made about $15,000,” came the reply from our eldest son, a keen cryptocurrency investor. “Bitcoin briefly pierced the $3,500 mark – an all-time high. The market cap of the...
  • Czar vs. Pope
      Vladimir the Great Sums Up Pope Francis the Fake Vladimir Putin has once again demonstrated why he is the most perceptive, farsighted, and for a politician, the most honest world leader to come around in quite a while.  If it had not been for his patient and wise statesmanship, the world may have already been embroiled in an all-encompassing global conflagration with the possibility of thermonuclear destruction.   Vladimir Putin is sizing up Pope Francis with his “good...
  • Bitcoin Has No Yield, but Gold Does – Precious Metals Supply and Demand Report
      Bitcoin and Credit Transactions Last week, we said:   It is commonly accepted to say the dollar is “printed”, but we can see from this line of thinking it is really borrowed. There is a real borrower on the other side of the transaction, and that borrower has powerful motivations to keep paying to service the debt. Bitcoin has no backing. Bitcoin is created out of thin air, the way people say of the dollar. The quantity of bitcoins created may be strictly limited by...
  • Is Historically Low Volatility About to Expand?
      Suspicion Asleep You have probably noticed it already: stock market volatility has recently all but disappeared. This raises an important question for every investor: Has the market established a permanent plateau of low volatility, or is the current period of low volatility just the calm before the storm?   All quiet on the VIX front... what can possibly happen? [PT] - click to enlarge.   When such questions regarding future market trends arise, it is often...
  • Will They Haul Off Trump’s Statue, Too?
      Confused by Shadows POITOU, FRANCE – This week, we are talking about theperishable nature of gods. Yesterday, the city fathers of our hometown of Baltimore let it be known that it was time to toss out the old deities.   The Robert E. Lee and Thomas. J. “Stonewall” Jackson Monument in Baltimore, which the mayor inter alia wants to remove. Suddenly it has become fashionable to erase the memory of an important part of US history all over the country. By experience, this...

Support Acting Man

j9TJzzN

Austrian Theory and Investment

Own physical gold and silver outside a bank

Archive

350x200

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com