Who
Will Be the Last One Holding Junk Bonds when the Music Stops?
“Troubled borrowers hide behind a
wall of yield-hungry investors.” Low
interest rates on benchmark bonds have driven investors to the worst-of-breed
CCC and B-rated junk bonds. Companies
have taken full advantage of this investor appetite by issuing $16.5 billion
worth of PIK bonds. These bonds allow
the issuer to make “payments-in-kind” with additional bonds (more IOU’s) in liu
of cash payments. According to the Bank
for International Settlements, new PIK bond issuance is nearly triple the amount
issued in 2012. The $16.5 billion has
now far surpassed the $11.1 billion issued in 2007, which coincides with the
end of the last credit cycle. BIS also
indicated that about 30% of issuers that issued PIK bonds in the previous cycle
have already defaulted.
Record sales of PIK junk bonds are
triggering uneasiness among international regulators concerned that investors
will suffer losses when central banks tighten monetary policy. BIS is nervous about the artificially low
default rate and what happens to the companies that have been hiding behind the
wall of liquidity. “What is happening in
corporate markets is unusual,” said BIS.
“It is as if the typical relationship with (the) macro economy has taken
a holiday. Spreads are low and so are
default rates…” (for now).
We here at Tradex have maintained
that we see cracks in the individual junk companies, long before the headline
default rate is flashed all over Squawk Box.
There are a lot of these “bad” bonds and a very small appetite from
banks and dealers in the current banking environment. So, who will be the last one holding these
when the Fed’s music stops.
Michael Beattie
Chief Investment
Officer
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