BofA Issues Dramatic Junk Bond Meltdown Warning: This "Train Wreck Is Accelerating"

Tyler Durden's picture

On Tuesday, Carl Icahn reiterated his feelings about the interplay between low interest rates, HY credit, and ETFs. The self-feeding dynamic that Icahn described earlier this year and outlined again today in a new video entitled “Danger Ahead” is something we’ve spent an extraordinary amount of time delineating over the last nine or so months. Icahn sums it up with this image:

The idea of course is that low rates have i) sent investors on a never-ending hunt for yield, and ii) encouraged corporate management teams to take advantage of the market’s insatiable appetite for new issuance on the way to plowing the proceeds from debt sales into EPS-inflating buybacks. The proliferation of ETFs has effectively supercharged this by channeling more and more retail money into corners of the bond market where it might normally have never gone.

Of course this all comes at the expense of corporate balance sheets and because wide open capital markets have helped otherwise insolvent companies (such as US drillers) remain in business where they might normally have failed, what you have is a legion of heavily indebted HY zombie companies, lumbering around on the back of cheap credit, easy money, and naive equity investors who snap up secondaries.

This is a veritable road to hell and it’s not clear that it’s paved with good intentions as Wall Street is no doubt acutely aware of the disaster scenario they’ve set up and indeed, they’re also acutely aware of the fact that when everyone wants out, the door to the proverbial crowded theatre will be far too small because after all, that door is represented by the Street’s own shrinking dealer inventories. Perhaps the best way to visualize all of this is to have a look at the following two charts:

So now that the wake up calls regarding everything described above have gone from whispers among sellsiders to public debates between Wall Street heavyweights to shouts channeled through homemade hedge fund warning videos, everyone is keen to have their say. For their part, BofAML is out with a new note describing HY as a “slow moving trainwreck that seems to be accelerating.” Below are some notable excerpts:

A slow moving train wreck that seems to be accelerating

For five months in a row now more than 50% of the sectors in our high yield index have had negative price returns. That’s the longest such streak since late 2008 (Chart 1). This isn’t to whip up predictions of utter doom and gloom as in that fateful year. But it’s a stark statistic, highlighting our principal refrain for the last several months – this isn’t just about one bad apple anymore. The weakness in high yield credit is to us not just a commodity story; it is about highly indebted borrowers struggling to grow, an investor base that cannot digest more risk, a market that has usually struggled with liquidity and an economy that refuses to rise above mediocrity. 


The problems in the coal sector that began to surface two years ago were perhaps the canary in the coal mine in hindsight. It was easy to dismiss a tiny sector with badly managed companies in a product that was facing secular headwinds as a one-off. But then we had the collapse in oil prices, much more difficult to ignore given the sheer size of the Energy sector in high yield. Barely had the market got its head around the scale of the issue when metals and miners started showing tremors. Now it’s the entire commodity complex. 

At this juncture, BofAML has a rather disconcerting premonition. Essentially the banks' strategists suggest that everything is about to become a junk bond, that corporate management teams will be tempted to resort to fraud, and that a dearth of liquidity threatens to bring the entire house of cards tumbling down:

Around this time last year, when our view on HY began turning decidedly less rosy, the biggest pushback we got from clients was that we were too bearish. A couple of months back, as our anticipated low single digit return year looked likely to come to fruition, many clients began to sympathize with our view, but challenged us on our contention that there were issues beyond the commodity sector. Tellingly, we now have an Ex- Energy/Metals/Mining version of almost every high yield metric we track (it started off as just Ex-Energy last year). Point out the troubles in Retail and Semiconductors and pat comes the reply that one’s always been structurally weak and the other’s going through a secular decline. Mention the stirring in Telecom and we’re told that it’s isolated to the Wirelines. When we began writing this piece, Chemicals and Media were fine, and Healthcare was a safer option; not so much anymore. At this pace, we wonder just how long until our Ex-Index gets bigger than our In-Index.

As Chart 2 shows, the malaise is spreading, albeit slowly. Price action has no doubt been violent over the last twelve months, but it has now started ensnaring non-commodity related bonds too. Over a third of the bonds that have experienced more than a 10% price loss this month belong neither to Energy nor Basic Industries. 


Admittedly, over the last few weeks several conversations have indicated a slow acceptance that the turn of the credit cycle is upon us. That however is just the beginning. We suspect that this is the start of a long, slow and painful unwind of the excesses of the last five years.

Along with decompression comes a tick up in defaults, and we expect those to increase in 2016 and 2017. Although a company with a poor balance sheet doesn’t necessarily default, all defaulted issuers have poor fundamentals- and we see a lot of companies with lackluster balance sheets and earnings. The difference why in one environment an issuer survives while in another it doesn’t has as much or more to do with risk aversion and the subsequent conscious decision to no longer fund the company than any change in leverage or earnings. And risk aversion, as noted above, is increasing amongst our clientele. As more investors continue to see the forest for the trees, we believe they will see what we have seen: a series of indicators that are consistent with late cycle behavior that we think clearly demonstrates a turn of the credit cycle. 

Finally, there is other typical late-stage behavior that is observable but difficult to quantify. We often see that a cycle is approaching its end when the bad apples start visibly separating out from the pack as idiosyncratic risk surfaces. We saw this first with Energy and Retail, then Telcos and Semis, and now creeping into some of the perceived ‘safe havens’ such as Healthcare and Autos. This is also when company balance sheets that have amassed debt during the cycle start to show visible cracks and investors question whether companies have enough earnings capacity to grow into their balance sheet. Terms of issuance become more issuer-unfriendly and non-opportunistic deals go through pushing new issue yields up. This is also a time when problems surface (Volkswagen), and negative surprises have the capability to cause precipitous declines in stocks and bonds (Valeant, Glencore).

Though we don’t and won’t pretend to predict the next corporate scandal or regulatory hurdle, what we do know is that as cycles become long in the tooth, companies could act desperately.  

In addition to a world of lackluster earnings, bloated balance sheets, and worrying global economic conditions, we’re hard-pressed to come up with any client conversation we’ve had on HY over the last 12 months that hasn’t included a tirade on appalling bond market liquidity.  

We’ve heard from several portfolio managers with many years of investing experience behind them that this is by far the worst they have seen. Anecdotal evidence from our trading desk also seem to support this view.

We certainly think liquidity is a problem in this market. In fact it was the very reason that our concerns about HY became magnified last fall, as the inability to enter and exit trades easily leads to more volatility and contagion into seemingly unaffected sectors (sell not what you want to, but what you can). 

Got all of that? If not, here's a video summary:

And then there is of course UBS, who has been calling for the HY apocalypse for months. Here's their latest:

Corporate credit markets have been under significant pressure in recent sessions, with idiosyncratic events erupting across the auto (VW), metals/mining (Glencore), TMT (Sprint, Cablevision), healthcare (Valeant) and emerging market (Petrobras) sectors, respectively. US IG and HY spreads widened 5bp and 27bp, respectively, to levels of approximately 180bp and 675bp, at or exceeding previous wides recorded in 2015.


Here's our short take: US high grade and high yield markets have suffered under the weight of weak commodity prices, heightened issuance (and the forward calendar), the rally in the long bond, rising idiosyncratic risks and illiquidity limiting the recycling of risk. Lower commodity prices are increasingly pressuring metals/mining and energy firms because prices are so low that many business models are essentially broken. Heavy supply, specifically in the high grade market, is a result of releveraging announcements to satiate equity investors and there have been few signs that management teams are retrenching – effectively setting up a standoff between equity and bond investors where ultimately the path to slower issuance is a broader re-pricing in spreads. Falling Treasury yields have chilled the demand from yield bogey buyers as rates have fallen faster than spreads have widened. Rising idiosyncratic risk, although it arguably is thematically symptomatic of late stage antics where firms are under massive pressure to boost profits (e.g., VW, Valeant), has added accelerant to the fire. And lack of liquidity has made the recycling of risk increasingly difficult.


The prognosis is challenging. Why? Certain aspects are structural in nature; in the later stages of the credit and asset price cycle one should expect greater net issuance from releveraging actions and rising idiosyncratic risk. Further, illiquidity is in effect part of the unintended consequences of post-crisis regulation. However, the outlook for commodity prices and, in turn, Treasury yields is arguably more balanced, but uncertainty around demand, supply and speculative conditions is elevated. But, alas, the primary driver of credit markets remains the same: commodity prices. We believe the market is now reflecting the thesis we have outlined in recent months: lower commodity prices will trigger rising contagion, and weakness will spread to the broader credit markets (in particular lower-quality high yield). Put differently, if commodity prices go lower, index spreads will go wider. This, in our view, is a virtual certainty.

The takeaway from this admittedly lengthy assessment is that between deteriorating fundamentals (e.g. depressed commodity prices), idiosyncratic risk factors, and the very real potentional for cross-sector contagion, the conditions are indeed ripe for, to quote BofA, the "acceleration" of the "train wreck." 

Make no mistake, we certainly can't imagine a scenario in which an "accelerating train wreck" could possibly be construed as a good thing, but when it comes to HY, the situation is made immeasurably worse by the state of the secondary market for corporate credit and the proliferation of bond funds. If HY collapses entirely and the redemptions start rolling in, it's difficult to understand how fund managers will be able to facilitate an orderly exit and on that note, we close with the following from Alliance Bernstein:

"In theory, investors can exit an open-ended mutual fund or an ETF at will. But the growing popularity of these funds forces them to invest in an ever larger share of less liquid bonds. If everyone wants to exit at once, prices could fall very far, very fast. A lucky few may get out in time. Others will probably get trampled."

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Bill of Rights's picture

Yes Ladies and Gents, the New York Obamacare Co-Op  pissed away $340 million dollars.


Regulators will shut down Health Republic Insurance of New York, the largest of the nonprofit cooperatives created under the Affordable Care Act, in the latest sign of the financial pressures facing many insurers that participated in the law’s new marketplaces.

The insurer lost about $52.7 million in the first six months of this year, on top of a $77.5 million loss in 2014, according to regulatory filings. The move to wind down its operations was made jointly by officials from the federal Centers for Medicare & Medicaid Services; New York’s state insurance exchange, known as New York State of Health; and the New York State Department of Financial Services.

In a statement, Health Republic said it was “deeply disappointed” by the outcome, and pointed to “challenges placed on us by the structure of t


SheepRevolution's picture

Martin Armstrong is looking pretty solid right now...

38BWD22's picture



BoAML is usually a little slow on the uptake.

Maybe "Junk is Good" now? *


* but not for me.....

Son of Loki's picture

That's nothing compard to the over $65 Billion a year in Medicare/Medicaid fraud.


That's very good busniess if you can get into it. Even ambulance services get in on the act:


Medicare's $30M ambulance-ride mystery



WASHINGTON (AP) — Medicare paid $30 million for ambulance rides for which no record exists that patients got medical care at their destination, the place where they were picked up or other critical information.

The mystery ambulance rides are part of a bigger problem with Medicare payments for transporting patients, according to a federal audit being released Tuesday.


It be a mystery!

Pairadimes's picture

Nobody could have predicted that. - Mr. Yellen

Jethro's picture

Institutional HOOCOODANOED?

zeroaccountability's picture
zeroaccountability (not verified) Son of Loki Sep 29, 2015 4:10 PM

Wait...doesn't that bomb-making kid Mohammed's dad own one of those 'emergency' hospital ambulance services?

And there's fraud there, you say?

Harnar's picture

Except that he denies gold manipulation. Hard to believe he can’t see it when it is obvious how the selling is done to move price rather than get the best price. Also note that he is mute on "UBS was granted conditional leniency in Swiss antitrust probe of possible manipulation of precious metal prices".

 This is Armstrong’s Building 7. If he is so off here, how can he be legit.

junction's picture

Just describe these agencies that shut down this Ponzi scheme non-profit as "La Cosa Nostra."  Cuomo's Mafia crime family in action. 

Mark Mywords's picture
Mark Mywords (not verified) Sep 29, 2015 2:08 PM

The HY apocalypse is not going to happen.

It IS happening.

knukles's picture

Best ever single leading indicator for the stawlk mahket.
Bond lead, equities follow.

KnuckleDragger-X's picture

Too bad it'll all be 'unexpected'........

J Jason Djfmam's picture

" Nobody could have seen it coming!"

    I cannot post this quip enough.

Oldwood's picture

An accelerating slow motion train wreck reminds me of the time my wife encountered one of those steel stanchions at the gas station with her car. Once she realized she had hit it, her only response was to gas it and power on through...the whole length of the side of the car.

We are at the point where no one doubts what is happening, yet they can't afford to acknowledge it, just pedal down, damn the torpedoes and full speed ahead. In reality they have no place left to go. They will ride it to the bottom all while in full denial. Its all going to shit so now denial at least provides them some cover against responsibility. I mean, really, how could they have known???

ebworthen's picture

"Not since 2008" or "Not since Lehman".

The ghost of Enron being associated with Glencore.

"Scrooge! (rattle of chains) Ebeneezer Scrooge!!!"

venturen's picture

hurry up close the barn door...oh wait...too late

tc06rtw's picture

 …  it’s about time for  Good Ol’ Queen Bess  to ask again:  “Why did no one see it coming?”

Oxbo Rene's picture

Everything is going according to plan ........

newbie vampire's picture

"Its all going to shit"

Even if some investors decide to exit NOW, how are they going to sell when buyers don't want to buy.

These HYs are also probably "covenant lite".   Good luck with holding on and collecting the interest coupons.

Will this wake up these investors and get them to lynch the Banksters ?

Sad to say, probably NOT !

Tom Servo's picture

it's also "transitory"


Oldwood's picture

"contained" as if in a slop bucket...

El Vaquero's picture

But not before it's "contained."

Winston Churchill's picture

Not long now knuks.

Bend over, assume the position, and kiss your 401k goodbye.

Can't even short it, the counterpartys are dead men walking.

38BWD22's picture




Best just stay away.

El Vaquero's picture

If this is the big one, you can short it.  You go max out your credit cards on useful stuff and wait for your creditors to go under. 

Oldwood's picture

You know you can't hide from that shit. No matter how small and shitty the bank, there will be someone who will buy up its debt, (probably with some implicit government backing behind it) and they will hire someone for $9/hr to hunt down every last collectible dollar. Your only protection, your only safety, is to have NOTHING anyone wants.

It would be an interesting experiment to see how many people would ask you for money if you never bathed and never wiped your ass....just sayin. Many of us struggle for legitimacy, for good credit ratings and good legal standing to only discover it makes us prime targets for every thief and mooch on the planet.

booboo's picture

Borrow money, buy gold, and join the homeless revolution. Every bird is edible including a politicians middle finger

chubbar's picture

This is an observation a buddy of mine made to me the other day. He doesn't make any money to speak of. Owns a relatively obscure house in an obscure area and is just happy that he isn't bothered by anyone hunting him down to steal from him. I thought he had a good point.

Oldwood's picture

The only two choices;

An intimidating presence, or

invisibility/ irrelevancy.

El Vaquero's picture

If you max out a credit card with a bank like Chase or BofA, and your creditor goes under, Junk Debt Buyers are going to be the least of all of our worries.  Our debt-is-money paradigm must come to an end for all of our sakes. 


Besides, junk debt buyers can be beaten in court a lot easier than original creditors, especially when the original creditor no longer exists.  Even if they can overcome the hurdle of the fact that their records are hearsay, they have a difficult time proving that they have standing.  I know one guy who beat a junk debt buyer at trial simply by attacking their standing.  They thought he was going to deny the existance of the debt, yet when the trial started he said "Your honor, to speed this up, I 100% owe this debt.  Just not to the plaintiff."  The business model that junk debt buyers use relies on the fact that when they sue, most people just roll over, don't respond to the complaint, and then they get a default judgment against them.  If everybody that they sued simply filed a response, it would break their business model's back. 


That being said, how well do you think that you can time SHTF?  I sure can't, and that is one short that you had better get the timing right on.  As a hedge, if you wanted to do something like that, you would want to go with Chase, because they aren't suing people over credit card debt right now. 

Oldwood's picture

Unfortunately I still suffer under years of parental indoctrination that drives me to actually be responsible for my commitments, pay my bills and the like. I would be a grumpy old ass indeed, if I started shitting myself now...even if everyone else was doing it. Somehow, somewhere, I still think all this shit comes back on us. Only an over rationalizing ass would tell himself that is was OK to lie, cheat and steal simply because it was done to you. We want a just and responsible world and have no chance whatsoever if we refuse to do so ourselves. Always waiting for someone else to go first....which is why I will likely finish last.

El Vaquero's picture

The people who would actually be getting shafted in that deal are the producers who accepted your funny money from the bank for their physical goods.  Bankers provide no real consideration to you when they loan you money, the real consideration comes from the vendor or producer, and the bankers skim off the top.  Is it immoral to scam a scammer?

stormsailor's picture

yeah oldwood, stuck in the same cunundrum.  watch amoral people succeed, suffer the consequence of character and integrity.


 For you see, the character that takes command in moments of crucial choices has already been determined.

          It has been determined by a thousand other choices made earlier in seemingly unimportant moments. It has been determined by all the little choices of years past—by all those times when the voice of conscience was at war with the voice of temptation—whispering the lie that it really doesn't matter. It has been determined by all the day-to-day decisions made when life seemed easy and crises seemed far away—the decisions that, piece by piece, bit by bit, developed habits of discipline or of laziness, habits of self-sacrifice or of self-indulgence, habits of duty and honor and integrity—or dishonor and shame.

          Because when life does get tough, and the crisis is undeniably at hand—when we must, in an instant look inward for strength of character to see us through—we will find nothing inside ourselves that we have not already put there.  Ronald Reagan

newbie vampire's picture

"wait for your creditors to go under. "

Wouldn't work unless you already have a new identity, preferably in another country.

upWising's picture

WHICH "position"?

The Patriot Position!  [arms spread against the wall, legs spread, pockets inside out, awaiting pat-down]

The Freedom Position!  [bent over, ankles firmly grasped, cheeks spread, awaiting put-in]


AMERICA!!  Jesus' Favorite Country! ©



Farmer Joe in Brooklyn's picture

Shorting now will be fine. Selling later will be tougher. 

When the markets come unglued, it will be good to be the only bid. Counterparty risk will become more of an issue in the later rounds of collapse (unless you are pretty unlucky). 

The key is to cover before shit gets too ugly...

Gamma735's picture

The best was companies selling bonds to buy back their own stock to raise eps growth.

newbie vampire's picture

"The best was companies selling bonds to buy back their own stock to raise eps growth."

Heh, more like ensuring the executive options stay in the money for looting.

donkeyhaute's picture

lots of rats abandoning ship in recent weeks.

Fish Gone Bad's picture

That image is not complete.  It has Yellen and Fink pushing the party bus up to a patch of oil in front of a cliff where they will crash down onto a big blackrock.

newbie vampire's picture

"crash down onto a big blackrock."

Change the big black rock to taxpayers and you will find the bagholders.  Time for the taxpayers to suck it up again.

But the TPTB wouldn't do that, would they ?


Seeing Red's picture

May the trampling begin.

thunderchief's picture

All warming up for and interesting Halloween. 

Wonder what the masks  will look like.

How about  the Donald for the  face and Hillary on the ass.