Bond market Update

First, lets look at Trace data:

I wont even bother continuing to point out the hi/low ratio - especially in high yield.  So much for the bubble!  Converts are naturally on fire as equities zoomed today (TMO continues to rock!).

Lets move on to CDS indices:

High yield continues to concern me that it is getting ahead of itself - or at least fully valued.  IG is near value - a little left, but not much.  There might be value in select EM credit, but one has to be very picky here.

And govvies:

Risk off - 'nuff said?  EU might raise rates, US economic data coming in stronger than expectations - the one two punch to globals.  Personally, I am short long US govvies as I feel (and pay) rising inflation that these intellectuals are gonna miss (perhaps they should do their own shopping - unless they shop ex-food and energy).

All in - good day for risk, bad day for "risk free".  Ride the wave friend - but wait for the numbers tomorrow to get the feel for risk positions.

Oh yeah, giving credit where due:  the charts today are from the WSJ online.  Usually I have to dig multiple sites, but tonight I was somewhat lazy.

Fixed Income Update

A post on some of the issues in the fixed income markets today.

Short-dated U.S. government debt prices fell to session lows on Tuesday after remarks from Richmond Federal Reserve President Jeffrey Lacker suggesting the central bank should scale back its $600 billion bond purchase program.  Given the recent data which points towards the footings of a recovery, I would expect we will hear more about scaling back QE2 which will continue to result in pressure on the front end of the curve.

Shorter-dated German bonds underperformed longer maturities on Tuesday with euro money market rates expected to come under renewed upward pressure after a low take-up of European Central Bank loans drained excess liquidity.  Commercial banks borrowed a total of 218 billion euros from the central bank's weekly and one-month tenders, less than the amount expiring and resulting in a 66 billion euro drain of surplus funds.  The liquidity taken out of the system does not help support fund raising by EU members and/or the Euro.  Should this continue, we should expect pressure on front end rates and the currency.

Moody's Investors Service said its measurement of debt defaults worldwide fell to 2.8 percent in January, a marked improvement form the 12.6 percent rate a year earlier. For the first time since 2007, Moody's said, none of the corporate debt issuers that it rates defaulted during the month. By comparison, there were eight corporate defaults last January. The January default rate was down from 3.2 percent in December. The ratings agency said the monthly decline in defaults is part of a gradual improvement in credit markets that should continue through 2011, although debt-laden European governments like Spain and Ireland could endanger the outlook. "We continue to expect stable, low default rates for the near future," Albert Metz, Moody's director of credit policy research, said in a statement. But Metz warned that if lenders become jittery and financing dries up again defaults could rise, particularly in Europe. For January, the U.S. speculative-grade default rate fell to 3 percent from 3.4 percent in December. In January 2010, that rate stood 13.7 percent.  By next January, Moody's predicts that the global speculative-grade default rate will decline to 1.5 percent. It expects the default rate will decline to 1.7 percent among U.S. speculative-grade issuers and to 1.1 percent among European speculative-grade issuers.  Lower default rates imply lower risk which further implies lower spreads (risk premiums) on corporate bonds.  While the market has tightened expecting this outcome, I believe it has further to go and that credit will outperform the risk free and generate positive excess returns.

Bottom line:  While risk free debt gets hit globally, risk assets will continue to perform - although not as well as they have.  We can see the risk appetite through the EETCs getting done, CMBS, drive by high yield deals and IG credit with virtually no covenant protection.

On the credit note:  let these cov lite and no covenant deals get done, do your homework and buy the prior issues with better covenant protection as documents are rarely priced into the market.  A little homework can help mitigate risk and lead to outperformance.

Another Day in Credit

Another day in the fixed income markets.

A quick look at the credit markets:

While volume was decent, the overall tone of the market was not.  As Europe continued to weigh heavy on participants, credit risk was not in favor.

New issues:

Kellogg-CoC                A3/BBB+  $1bn       10y   T+90

Church & Dwight      Baa3/BBB-   $250mm   5y   T+150

Hershey Co -CoC         A2/A        $350mm  10y   T+88

HealthCare Realty    Baa3/BBB-   $300mm  10y   T+262.5

Societe Generale      Aa2/A+       $250mm   3yFRN 3ml+132
Societe Generale      Aa2/A+       $1bn         3y    T+158
Societe Generale      Aa2/A+       $750mm   5y    T+175

Overall issuance volume was decent, but a little light.  Haven't seen the deals break, but most priced at the tight end of guidance so there isn't a lot of juice here.

Secondary volume was decent, but the tone was negative.  Below is the trace data showing the negative adv/dec ratio.

So how did the equity equivalents do (yeah, the ETFs):

 

JNK outperformed PFF today, as it has for the last 2 months.  While much has been said about the outflows recently, performance must not have gotten the memo.  PFF was outperforming until about September, but since then JNK has been on fire, following equities up (and if the past is any indicator, JNK has a bit to run to keep pace - below).

 

I am still a believer in credit here (yeah, we will have risk-free issues, but excess performance is another beast) as the risk premium is still wide to historical standards.

Disclosure:  Long LQD, AGG, various preferred and HY.

Moodys on the Ratings Assigned to Companies Emerging from Bankruptcy

A couple tidbits from a Moodys report entitled "Ratings Assigned to Non-Financial Corporates Emerging from Bankruptcy" (11/9/2010).

Companies Emerging from Bankruptcy are Typically Assigned Single-B Ratings Exhibit 1 below shows the distribution of corporate family ratings (CFRs) newly assigned to 84 companies that filed for bankruptcy sometime after January 2000.  The data show that 77% of these ratings were single B, while approximately 15% were Ba3 or higher and 8% were Caa1 or lower.

The predominance of single B corporate family ratings assigned to companies emerging from bankruptcy can largely be accounted for by two factors.  First, the amount of pre-petition debt extinguished during Chapter 11 proceedings often results in companies that emerge with financial metrics (e.g., leverage and coverage measures) similar to those of other single-B issuers as outlined in applicable industry rating methodologies.  These financial metrics reflect the outcome of Chapter 11 proceedings which attempt to balance the competing goals of providing for a viable going-concern business while minimizing losses to pre-petition debt holders.  The data indicate this balance is often achieved by companies emerging from bankruptcy with financial metrics similar to other single-B issuers.  

Second, bankruptcy often results from factors other than high debt levels, including weak business models or poor management.  To the extent that a given Chapter 11 proceeding did not address these types of fundamental business considerations, the ratings at emergence would usually be constrained to single B or below. 

While the results above (in the report but not in my post) suggest that past ratings assigned to companies at emergence from bankruptcy may have been modestly too conservative, there are several caveats.  First, and most importantly, the default and transition rate results for emergers are based on a very small sample of issuers.  For example, the sample of single B emerging issuers is only 56, which compares against over two thousand issuers for the all corporates results.  And the number of emerging issuers underlying the Ba and Caa-C results is only 19 and 29, respectively.  Given these small sample sizes, it would have required only 1-2 additional defaulters by emerging issuers over the ten-year sample period to reverse the conclusion that default rates on emergers are lower than for all corporates.

Rest of report here: Moodys on Bankruptcy Emergers

I found the report - and its conclusions - interesting and worthy of note.  If the sample (admittedly small) is representative of a broader group of "bankruptcy emergers", then companies emerging from bankruptcy and rated BB (possibly up to low BBB) could be decent trades/positions.  If they are priced cheap to the BB bucket and/or peers, it is worth taking a deeper look at the company.  If the industry is viable, fresh start accounting helps the company to be viable.  Not gospel, but something to try to disprove.  Just thinking out loud.

Be careful though, because Yes, There Will Be Blood.

Global Default Rates Fall - Momentum Still on the Side of High Yield

Default statistics for October showed the global issuer-weighted speculative grade default rate fell to 3.7% from 4.0% in the prior month on a LTM basis, which is the 11th consecutive monthly decline, according to Moody’s data. The US default rate fell to 3.6% from 4.0%, while the European default rate decreased to 2.8% from 3.5%. On a par-weighted basis, the global default rate fell to 1.4% from 2.0% in September, while the US rate declined to 1.1% from 1.8% and European rate to 2.4% from 2.6%.

This information continues to support the risk buying habit of the market.  Lower default rates lead to lower risk premiums (spread).  The high yield sector continues to march forward, with issuance to date setting records.  Spreads tighter, covenants looser - back to the future.

Emerging Market Credit - One Sided Trade

Bloomberg:

The yield gap between junk-rated company bonds and investment-grade debt in emerging markets is near the smallest since June 2008 as less creditworthy borrowers benefit most from cash pouring into developing countries.

The spread has narrowed to 225 basis points, or 2.25 percentage points, from this year’s high of 314 basis points on June 8 amid a worldwide rally in corporate bonds. The gap reached 217 on Oct. 15, a 28-month low and the smallest since before Lehman Brothers Holdings Inc. collapsed.

JPMorgan Investment Grade Corporate Emerging Market Bond Index (yield):

Setting up for an intermediate term short.  The risk trade seems to be one sided - never a good bet.  Yes, there is momentum and yes, there will be blood.

Fund Flows - October 27, 2010

All Taxable Bonds saw total positive inflows of $4.2 billion, or (+0.4%) of assets.  Ranking inflows YTD as a percentage of assets, EM Debt is first with $12.5 billion followed by Bank Loans with $11.2 billion and Global Debt $43.5 billion. Money markets saw positive inflows of $17.3 billion, or (+0.7%) of assets.  Equities saw $5.2 billion in positive inflows, or (+0.2%).  Money Markets have seen the greatest net outflows YTD of $437 billion, or (-13.6%) of assets.

 The money flow into risk is somewhat disconcerting.  The reach for yield is obvious in the fund flow tables as well as the focus on dividend producing equities.  While rates are low (and will, most likely, stay this way for some time) the increase in risk appetite to feed the yield beast rarely, if ever, works out longer term.  That said, flow (momentum) is on the side of risk, so catch a wave, ride returns, keep an eye on the risk trade and use stops.

I was talking with some sell-side friends yesterday and they mentioned that the demand for high yield continues unabated - deals are massively oversubscribed, allocations are severe and covenants getting light.  Don't like it, but have to buy the trade.  HYB for at least a 5% allocation continues to be warranted.