8.03.2010

Credit Market Quite Possibly Insane

Last week, I said the high yield market was hot. Today I am saying the entire credit market is quite possible insane. Toro's Running of the Bulls has been one of my favorite investing blogs for a long time. He recently penned an incredible piece entitled: The Bond Market Has Lost It's Mind. As you can tell, I am less than original in the title of my post. That being said, I would like to provide some "on the ground" intelligence if you will of what I am talking about.


As anyone in the credit markets are well aware, the primary market is running hotter than I can ever remember (except maybe bank debt in 1Q 2007...go CLO machine go!). And this turned on a complete dime relative to where it was just 6 or 7 weeks ago. I cannot recall a high yield deal (or investment grade deal for that matter) that was not oversubscribed and didn't trade up at least 1 point on the break.

Allocations are disgusting. Seriously. Unless you are Oaktree, Pimco, Franklin, etc, you are getting a couple million bonds here and there. Last week on the Distressed Debt Investors Club Forum, I posted a new topic about the Borgata deal currently in the market. At that time it was being talked at 10.5% which I found attractive given the risks inherent in investing in a single site casino in Atlantic City.

So I get a Bloomberg early this morning saying pricing is coming 75 bps tighter on the 5 year and 50ish tighter on the 8 year. And then I hear from my sales coverage: There is $5 billion in the book for an $800M deal. I will probably get 1/10th or 1/20 of my initial commitment.

Deals are pricing just incredulously tight. Teck Resources was in the market today and got a 7 year deal done at a 160 spread versus the curve translating into an all in yield of 3.858%. That's a low BBB issuer folks whose bonds were trading at 40-50 (Yield of 14-16%) about a year ago....


Now, I understand the bullish arguments. Rates are going to stay low, and possibly go lower if deflation kicks in, corporate balance sheets are healthy, earnings are coming in higher than consensus, excess liquidity in the market, investors are reaching for yield...

From a Bloomberg Article this evening (on Bloomberg you get high yield news with the function HYLN :
Investors are putting cash into junk-bond mutual funds as money market funds from companies such as Federated Investors Inc. and JPMorgan Chase & Co. offer yields at or below 0.25 percent, according to data compiled by Bloomberg.

"The average retail customer can’t live on 1 percent and that’s the issue,” said Jon Budish, senior vice president of high yield at Jefferies & Co. in Short Hills, New Jersey. “Until the default rate changes or you get a lot of downgrades, or until the Fed says something different, high-yield seems pretty interesting.”
Now, I do not invest top down. I look at securities across the capital structure (bank debt, investment grade, high yield, equities, and distressed) and determine my downside risk and if I am being compensated for taking that risk (as defined as permanent loss of capital). And frankly, while the upside / downside was quite favorable in 1Q and 2Q 2009 and to a lesser extend in the back half of the year, now things are just ludicrous.

I would venture to guess that my "new issue hit rate" is less than 10% in 2010. And you know what? I look like an idiot. And when new issues are up 2-5 points, it is my experience these things feed on themselves. Flippers start piling in when they know deals are oversubscribed, complicating allocations, and effectively "window dressing" the analysis of the issuer at hand. Rinse, repeat, and oh yea, put me in for $50M of XYZ bond even though I'll probably only get $3 or 4 million but I can probably sell it at 102 and make an easy 80k-100k.

Surprisingly, a lot of distressed credits seems to be very much under performing the on-the run credit markets. At least it feels that way. According to JPM, YTD performance for CCC bonds is 10.3% and BB bonds is 8.4%. From a yield to worst perspective, we are way below the long term average, yet from a spread to worst perspective we are 20-30 bps wide of the long term average.

Given where coupons have been printing, duration is creeping higher and higher as more treasurers are doing 30 year deals at very low coupons. And given where rates are today, doesn't that scare anyone else other than me? The 30 year Teck bond has a duration of 14 (using round numbers). That means a 7 or 8 bps move in rate or spreads is equivalent to 1 point change in bond value. Am I the only one that thinks that at least one of those two will definitely be wider in the next 4 or 5 years? Let me know your thoughts.

3 comments:

Anonymous,  8/04/2010  

Nice post Hunter. Agreed that things are out of control. I cant even get engaged on what I think are decent bids. My sales guys all have the same story. "Everyone has too much cash."

Anonymous,  8/04/2010  

100% agreed Hunter. My fund is not getting any allocations and I just can't believe where spreads are. It is seriously just mind boggling. I feel like this will not end well. Great post.

-shaunsnoll

Guillermo 8/05/2010  

I completely agree with you Hunter. Two years of watching the flow-of-funds has me staring wide-eyed at my screen. I've been arguing the case for going long zeros for months too early, but I just can't follow on that anymore. At rates this low, when the positive convexity feeds the self-feedback loop it gets a little scary because the price curve gets so much steeper that a few bps here and there can really ruin your day, as you said.

That being said, after looking at some of the recent issues being pumped out by banks, for example a 20y BoA, FDIC-insured floating ((30yCMS - 2YCMS - 87.5bps) * 4) [06051VTG1] and a similar issue from citi [] or another BoA [06048wcs7]((30y-2y-25bps)*4) say one thing: We are going to fleece retail by teasing them with a high initial yield, and then pay nothing for years. The banks expect further flattening as the fed goes out further in the curve, and I have to agree. The current deflationary pressures have a lot of momentum and will take years to clear up.

That being said, the flood of liquidity is definitely distorting things even more as cash just sits idle in mmkts, fueling low repo rates and enabling players of the curve to take the carry by borrowing short, which is all well and good buuuuut, if the fed doesn't mantain the size of their balance sheet as refis / payments shrink their ABS assets, I definitely expect the effects to reverberate across the entire market. this is all going to end in tears.

Email

hunter [at] distressed-debt-investing [dot] com

About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.