Watch Out for a Doubling of Junk Defaults, Warns Gundlach

Jeffrey Gundlach (photo courtesy of DoubleLine Capital)

Junk bond defaults may double soon, according to Jeffrey Gundlach, dubbed the Bond King. And that’s despite Federal Reserve efforts to prop up high-yield issues.

“There is room to go on the upside” with default rates, he warned on a webcast sponsored by his firm, DoubleLine Capital. The protracted recession will put highly indebted companies with junk ratings under increasing pressure, he reasoned.

The title of his program was “Hey Kid, Want Some Candy?” Implication: Some bond investors are enticed by the sweet (relatively speaking) payouts of junk bonds, but that won’t be healthy for them in the long run.

The Fed has pumped more money into the economic system, but that hasn’t erased “economic fundamentals,” he cautioned. Many junk issues are overpriced amid investor euphoria, he said. Thus, recovery rates—the portion of a defaulted bond’s face value that investors may actually recoup in a restructuring—will be lousy, he added. “There are many junk bonds that are priced today, or certainly were a week ago, at levels in excess of the recovery rate should they default,” he said.

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Right now, the portion of US junk issues that aren’t paying interest has been steadily rising, hitting 8% last month, says Moody’s Investors Service. Defaults are up from 4.2% at the end of 2019 and 4.4% right before the coronavirus began spreading in the US in March.

Nevertheless, yield-starved investors have flocked to buy the speculative-grade paper. Last month, the US high-yield market expanded $1.36 trillion, up 15% from 12 months earlier, as the result of new issuance and also demotions from investment grade.

The Fed has pledged to buy these new arrivals to junk-land, known as “fallen angels,” as well as to purchase exchange-traded funds (ETFs) dedicated to junk. Although the central bank has said it won’t go for older junk, and hasn’t bought that much high-yield anyway, the halo effect of its intervention has reassured investors about the entire speculative-grade spectrum.

Right now, half of investment-grade corporate debt is at the category’s lowest rung, BBB. If 50% of that were to be downgraded to junk, this would magnify the risk for junk investors, Gundlach argued. In the Great Recession, junk defaults topped out at around 12%.

Gundlach criticized the Fed’s campaign to bolster risky assets such as junk bonds. That, along with federal government stimulus spending, has prompted what he termed as unsustainable corporate borrowing binges. “It’s foolhardy to believe that one can have this kind of a shock to an economy and it just gets healed through a one-shot deal” from Washington, he said.

Gundlach Says Fed ‘Panicked’ by Cutting Rates

Despite Fed Backstop, Junk Bonds Still Face Big Trouble

Tags: defaults, fallen angels, Federal Reserve, investment grade, Jeffrey Gundlach, Junk Bonds, Stimulus

The Pension Benefit Guaranty Corporation (PBGC) has taken over responsibility for the McClatchy Company Retirement Plan, which covers more than 24,000 current and future retirees. The pensions lifeboat estimates that McClatchy’s plan has a funded ratio of 57%, and is underfunded by $1 billion with approximately $1.3 billion in assets and $2.3 billion in liabilities.

In February, the McClatchy Company and 53 subsidiaries filed for Chapter 11 protection in the US Bankruptcy Court in Manhattan, and in August, a bankruptcy court approved the sale of substantially all assets of McClatchy and its subsidiaries. On Sept. 4, the sale was completed to Chatham Asset Management and McClatchy’s 30 news organizations and all of its employees transitioned to a new private entity under Chatham ownership. The PBGC terminated the pension plan, effective Aug. 31, and has become the statutory trustee.

“PBGC’s mission is to help protect the retirement security of millions of the nation’s workers, retirees, and their families, and that’s exactly what we have spent months doing in the McClatchy bankruptcy,” PBGC Director Gordon Hartogensis said in a statement. “By assuming responsibility for the plan, we are securing the benefits of the McClatchy plan’s participants.”

The PBGC said McClatchy retirees will continue to receive benefits without interruption, and future retirees can apply for benefits as soon as they are eligible.

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The agency will pay pension benefits earned by McClatchy’s current and future retirees up to the legal limits.

The PBGC also said the claim resulting from termination of the McClatchy pension plan was not included in the agency’s fiscal year 2019 year-end financial statements, but it would be included in its fiscal year 2020 year-end financial statements. McClatchy’s non-qualified pension plans, such as the McClatchy Supplemental Executive Retirement Plan or the former Knight Ridder Benefit Restoration Plan, will not covered by the PBGC and the rights and recovery will be determined by the courts.

“Our aim was to permanently address both the company’s legacy debt and pension obligations and strengthen our balance sheet,” Craig Forman, president and CEO of McClatchy, said in a statement in July when Chatham successfully bid for the newspaper company.