Desperate borrowers and stupid investors

Is one investor’s junk (bond) someone else’s treasure? Hardly. There is no point in earning a high return or yield on your investment if you lose all of your capital.

US and European credit markets have been hives of intense, record-breaking activity since late March as lesser rated borrowers rushed to build cash reserves ahead of expected troubled times and investors sought higher returns compared to the low returns from higher rated borrowers and the extremely low (or negative in some cases) returns from the traditional safe haven of government bonds.

Travel bans in US, Europe and UK suddenly halted the income for businesses in tourism and hospitality, such as airlines, cruise lines, hotels and resorts, rental car companies and airport owners/operators. The spread of coronavirus and subsequent lockdowns of businesses and households in the US, Europe and UK not only exacerbated the situation of those in tourism and hospitality but also spread the cessation of income to other sectors.

In such sudden and dire circumstances, it is no surprise that credit margins rose dramatically because borrowers rushed to issue debt (rightly so to create funds for future debt obligations and cash flow requirements) and investors demanded higher returns (rightly so because of higher systemic, industry and borrower specific risks). In other words, the so-called free market adjusted the rewards to counter the greater risks.

What is a surprise is the eagerness of many investors to buy the debt of (invest in) companies with very limited, or close to no, income projected for the next three to six months and in industries that have all but collapsed in the wake of the COVID-19 pandemic, i.e. businesses with very high default risks.

The cruise line Carnival issued USD4 billion in bonds backed by 86 of its cruise ships and intellectual property. Norwegian Cruise Line issued USD675 million of bonds at a yield of 12.575% secured by islands it owns in the Bahamas and Belize. Delta Air Lines issued USD5 billion of bonds and loans backed by landing rights and routes. What would all this collateral be worth in the event of bankruptcy, especially if the cause is systemic?

Debt raised by a number of US airlines, rental car companies and cruise lines have been issued at eye-watering margins and eagerly snapped up by investors. Yet, investors bought bonds issued by Avis even though Hertz went agonizingly close to filing for bankruptcy (for now) and airlines continue to issue bonds even after United Airlines pulled its proposed bond offering because investors balked at the (weak) collateral security offered.

Can someone tell me who these investors are?


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