Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

You know a junk-bond deal is truly outrageous when the $30 million golden parachute it bankrolled isn't even the most objectionable part.

The transaction in question, highlighted on Wednesday by Sridhar Natarajan and Anders Melin of Bloomberg News, involved Ferroglobe Plc, a silicon producer that borrowed money to pay its former executive chairman the nearly $30 million, roughly equal to what it gave to all its shareholders over an entire year. What was the accomplishment so deserving of this payout? He left the company.

The deal is alarming on many levels. First, the company didn’t show the best judgment by agreeing to such a huge golden parachute relative to its income. The former executive chairman, Alan Kestenbaum, resigned recently, about a year after merging his North America-focused Globe Specialty Metals with Ferroglobe. So his compensation could be considered part of that deal.

But still, this package was far bigger than normal and comes as Ferroglobe is expected to post an annual loss.

Second, this pay scheme was so out of whack with the company’s balance sheet that it was forced to get help from junk-bond investors, paying them a hefty 9.38 percent interest rate. That’s high relative to other debt with similar ratings and most likely reflects the skepticism that investors had about the purpose of the deal.

Hefty Premium
Ferroglobe agreed to pay higher yields on its latest debt offering compared with similarly rated notes
Source: Bloomberg, Bank of America Merrill Lynch index data

And that brings us to the third, and possibly most outrageous aspect. Investors cast aside whatever doubts they had and lent this company the money, which totaled $350 million and included that special provision to pad Kestenbaum's personal bank account. Instead of forcing some restraint on Ferroglobe, they simply enabled it to proceed with yet another bad decision, hoping to earn a big yield in the process.

After all, junk bonds are hot. Sizzling. Fund managers have generally been penalized for their skepticism over the past eight years, with U.S. high-yield debt posting average annualized returns of 13.3 percent since the end of 2008.

Winning Bet
U.S. high-yield bonds have generally been a good bet for investors since the crisis
Source: The BofA Merrill Lynch US High Yield Index

Investors apparently can’t imagine a company going bankrupt anytime soon, given a generally positive economic outlook. And as long as corporations can keep borrowing money at relatively affordable rates, they can stay current on their obligations and keep this illusion of safety in risk alive.

This Ferroglobe deal is not an isolated one, either. Private-equity companies have also taken advantage of investors’ seemingly insatiable appetite for riskier debt. Apollo Global Management, for example, turned to the speculative-grade loan market to give itself an $800 million dividend on ADT Corp., more than twice that company’s recent annual earnings, as Bloomberg’s Natarajan and Sally Bakewell highlighted earlier this month.

Steady Sales
Companies have been selling junk-rated bonds at a steady pace to start the year
Source: Bloomberg

The more this type of activity continues, the weaker the $1.3 trillion U.S. high-yield bond market becomes in a downturn. Just because this debt has been a great bet since the financial crisis doesn’t mean it will continue forever. At some point, this lack of discipline will come back to haunt investors and companies alike.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net