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Jump Risk Jumps After American Bankruptcy, Sends Junk Plunging As Major Debt Refi Cliff Approaches

Tyler Durden's picture


A week ago, the reputation of legacy carrier American Airlines as being the only one to avoid bankruptcy is not the only thing that went pop. Along with it went the fervent optimism of high yield debt investors that moral hazard spreads not only to insolvent countries and insolvent banks, but to all insolvent corporates. On Wall Street, there is actually a technical name for perspective on insolvency optimism when viewed through the prism of CDS, where it is known as "Jump Risk", or the likelihood of a company to file tomorrow as opposed to a year from now. Until AMR, jump risk was not an issue. Now, it has come back with a vengeance. As Bloomberg LevFin magazine reports, "AMR’s bankruptcy is taking the corporate debt market by surprise, with investors losing 25 percent on bets in junk-bond derivatives that there wouldn’t be a jump in defaults this year. The Chapter 11 filing from the parent of American Airlines is helping to fuel a plunge in the value of credit-default swaps that  take outsized losses when companies in a benchmark index fail. The contracts, which back the debt of borrowers including ResCap and Radian, plunged to 64 percent of face value as of yesterday from 85 percent on Nov. 8. The derivatives were three weeks away from expiring with gains on Nov. 29, when AMR filed for protection." Oops. Alas, that's what happens every time unfounded optimism gets away from reality, especially when one is dealing with "junk", literally, which as the name implies is one TBTF if it is 99% unionized.

Bloomberg has more:

The failures of AMR, and those of Dynegy and PMI, are driving investors to recalibrate their expectations for when borrowers may miss debt payments as companies that aren’t considered immediate candidates abruptly fail. That’s a scenario known among debt traders as jump-to-default risk.


“People are really worried about jump risk,” said Mikhail Foux, a Citi structured credit strategist. “If you asked people in June, July, or even August,” he said, most “said defaults at some point were going to pick up, but that it was unlikely to be soon.” Even after accounting for AMR’s failure, swaps that protect against further defaults before Dec. 20 in the benchmark Markit CDX North America High Yield index, Series 11, were trading last week at 10 percentage points below face value, according to Citi. Investors were using index tranches to earn yields that in April were more than twice those of typical high-yield bonds, which were about 7 percent.

Is AMR the last one? Hell no:

The upfront cost of CDS on Radian for the next year surged 49 percent since Sept. 30, compared with a 21 percent increase on five-year contracts, according to CMA. One-year swaps on ResCap surged 187 percent and five-year contracts jumped 140 percent on speculation Ally will place its unit into bankruptcy.

Alas, the market buy first, and asks questions never, as has always been the case:

The global default rate for speculative grade debt rose in October after five months of easing, with the 12-month trailing rate increasing to 1.68 percent from 1.65  percent in September, S&P said. In April, when speculative-grade yields were at about record lows and Moody’s predicted the global default rate among junk-rated issuers would drop to 1.5 percent by year-end, investors were paying more than 88 percent of face value for the lowest-ranked high-yield index tranche, a price that would have returned an annualized 17 percent had none of the companies in the benchmark defaulted.

And while the discrepancy between reality and optimism always leads to casualties, a far bigger issue is the upcoming roll cliff in not only sovereign and financial debt, but in bank debt as well. Which in 2012 and 2013 will be a rude wake up call to many companies which may do the AMR thing and simply opt the Chapter way out:

From Bloomberg:

Speculative-grade bank debt maturing in 2012-2013 may triple to almost $100 billion from $32 billion, leading to an “unexpected” surge in leveraged-loan issuance, according to Moody’s. The rise will be driven by companies accelerating the refinancing of 65 percent, or almost $39 billion, of the total junk-rated bank credit maturing in 2014, Moody’s analysts led by Tiina Siilaberg said yesterday in a report. “Most maturities are pulled forward by one year,” Siilaberg wrote. “In 2013, we  expect approximately $30 billion to be pulled forward from 2014.”

The party in high beta fixed income is about to end.


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Wed, 12/07/2011 - 15:44 | 1955787 Tsar Pointless
Tsar Pointless's picture

Might as well jump. Go ahead - jump. Forget it and jump. Go ahead - jump.
With apologies to those who hate the David Lee Roth flavor of Van Halen

Wed, 12/07/2011 - 18:40 | 1956572 TheFourthStooge-ing
TheFourthStooge-ing's picture

There's always the Aztec Camera version:


Thu, 12/08/2011 - 04:15 | 1957630 Ted K
Ted K's picture

How much did Aztec Cams pay Hagar for that??? That's better than his usual version.

Thu, 12/08/2011 - 04:08 | 1957623 Ted K
Ted K's picture

Don't be ragging on Diamond Dave.  He's the only one at the concerts who acts like he gives a shit about fans.  A guitarist who looks drunk, a bass player who stands on stage like he's waiting for movie tickets as he fingersyncs to Michael Anthony, and a drummer past his prime.  Dave "brings it" at least. And Diamond Dave doesn't LIE to fans like Eddie "I'm so insecure I bully this band like a 12 year old starting a band in my garage" Van Halen does.  Michael Anthony lasted in that band because he was willing to be shit on on a daily basis.  Dave NEVER played that game.

Wed, 12/07/2011 - 15:45 | 1955788 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

Your shit is junk, bitchez!

Wed, 12/07/2011 - 15:46 | 1955790 distopiandreamboy
distopiandreamboy's picture

Air France flight 447 is cleared for take off

Wed, 12/07/2011 - 15:47 | 1955793 Sophist Economicus
Sophist Economicus's picture

See RISK jump.   Jump RISK jump.   Jump, Jump, Jump...

Wed, 12/07/2011 - 15:52 | 1955803 SheepDog-One
SheepDog-One's picture

Jump risk jumps on junk...may as well JUMP! Sure wish we could see some bankers jumping out of windows on Wall St.

Wed, 12/07/2011 - 16:28 | 1955957 CPL
CPL's picture

Jump fuckers!!!  JUMP!!!


What a retarded market day.

Wed, 12/07/2011 - 16:05 | 1955804 Captain Benny
Captain Benny's picture

And it's gone.  It's all gone!

Jump you mother fuckers.  Jump.


Its an all out run for cash right now and I'm laughing my ass off.  Better get the deer pic ready, the market is about to have a flash crash incident.

Wed, 12/07/2011 - 15:53 | 1955814 SheepDog-One
SheepDog-One's picture

Bad news? Who fell asleep at the editors desk? We're SUPPOSED to be having a wild Santa rally!

Wed, 12/07/2011 - 17:56 | 1956413 Smiddywesson
Smiddywesson's picture

I am guilty of calling that rally, but it looks like the market's been naughty, not nice.

Wed, 12/07/2011 - 18:55 | 1956614 TheFourthStooge-ing
TheFourthStooge-ing's picture

Wild Santa rally?

Ho Ho Ho!!


Wed, 12/07/2011 - 15:58 | 1955834 Xkwisetly Paneful
Xkwisetly Paneful's picture

California's and Illinois' state debt is junk quality. It ain't going to take much in higher rates to push them off a cliff.

Wed, 12/07/2011 - 15:59 | 1955839 Caviar Emptor
Caviar Emptor's picture

No! My Empire of Junk : It's Melting!!!

Wed, 12/07/2011 - 16:01 | 1955849 Caviar Emptor
Caviar Emptor's picture

When junk turned to junk, then to gold and back to junk again: a history of the LBO-driven false prosperity that left America with, well, junk

Wed, 12/07/2011 - 19:09 | 1956640 TheFourthStooge-ing
TheFourthStooge-ing's picture

Whaddaya expect when dealing with junkies?


Wed, 12/07/2011 - 16:04 | 1955863 way-out-west
way-out-west's picture

All those banks can just jump on my junk...

Wed, 12/07/2011 - 16:07 | 1955877 firstdivision
firstdivision's picture

Wow!  2016 looks like a long shot at even being remotely covered.  Ben better fire up the printing press to bring down the cost of paying that outstanding debt.

Wed, 12/07/2011 - 16:07 | 1955878 earleflorida
earleflorida's picture

a chinese junk just left the harbor,... report is, several coolies jumped ship -  drowning at sea

Wed, 12/07/2011 - 16:14 | 1955904 muhuca
muhuca's picture

Chart doesnt match article.  The article talks about the HY market, chart is a picture of leveraged loan maturity wall.

Wed, 12/07/2011 - 16:16 | 1955911 MFL8240
MFL8240's picture

Goldman Scahs posted list of 2012 investments includes High Yield Bonds, which put another way are junk bonds.  They CANNOT be trusted on anything.

Wed, 12/07/2011 - 16:20 | 1955923 death_to_fed_tyranny
death_to_fed_tyranny's picture

This Fucking Ponzi is unravelling. All the printing cannot stop the inevitable plunge. The nexus is right here. Right now. Let it crash!

Wed, 12/07/2011 - 16:22 | 1955930 ghostfaceinvestah
ghostfaceinvestah's picture

How is it a suprise that RDN (or MTG for that matter) are going to default?

Wed, 12/07/2011 - 16:23 | 1955935 Dr. Engali
Dr. Engali's picture

I have never been able to understand how an airline can continue to come to the capital markets and raise money. Who invests in this crap? Somebody who needs a guarranteed tax loss ?

Wed, 12/07/2011 - 17:30 | 1956327 Hippocratic Oaf
Hippocratic Oaf's picture

Depends on timing. Do you think AMR JFK's 5.40's of '20 will come back at some point before 2020? They're trading at 20 cents on the dollar.

Gate receipt bonds, same name 8's of '12 trading at 90.00 

This is the pattern that airlines have taken for years. If you own it at par and dump the fuck at're fault. Buy at 20 and see it go higher......who's the fool?

Airlines can always raise money, just at higher rates and, get side investors that invest in crap!


Wed, 12/07/2011 - 16:29 | 1955961 Gidas19
Gidas19's picture

when is AMR going to trade on pinks?

Wed, 12/07/2011 - 16:37 | 1955985 non_anon
non_anon's picture

ha ha, suckers!

Wed, 12/07/2011 - 16:46 | 1956044 J 457
J 457's picture

Who has the list of HY companies with debt maturity in 2012/13 that might follow in the steps of AMR?

Wed, 12/07/2011 - 17:22 | 1956237 Variance Doc
Variance Doc's picture

This is also known as contagion.  Very sophisticated intensity based default models incorporate contagion as a factor that effects the probability of default.  This is a hot area of research in finance/financial engineering.

It will very interesting to see what future default data (and there will be lots of defaults in the coming years - just due to declining growth!) will challenge the default models.

Also, Tyler states "Until AMR, jump risk was not an issue.", which is complete BS.  Many researchers (including me) have shown, both theroretically and empirically, the contagion or "jump risk" has always been present in modern finance.

Wed, 12/07/2011 - 19:10 | 1956642 J 457
J 457's picture

Names please....

Wed, 12/07/2011 - 20:54 | 1956839 Gidas19
Gidas19's picture


Wed, 12/07/2011 - 17:56 | 1956414 casfoto
casfoto's picture

you can't jump out of the basement....

Wed, 12/07/2011 - 18:04 | 1956453 FranSix
FranSix's picture

Its ironic an airline bankruptcy becomes the black swan that just might very well take down the system.

In the airline industry nobody goes to jail for criminal negligence, despite having exhaustive, expensive forensic investigations after crashes.  Sounds like the banking sector,  no?

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