HIGH YIELD FLASH UPDATE: The Truth

How did the “Experts” Miss the Obvious?

§  UNBIASED OPTIMISM – Apr 11, 2006 – Peterson’s Institute for International Economics – “…With continued strong productivity growth and some recovery of participation, potential GDP growth should be in the 3 to 3¼ percent range…”

§  ROSY OUTLOOK FROM SAN FRANCISCO FED – Nov 11, 2006 – Federal Reserve Bank of San Francisco – “…cooling in housing markets with solid growth in the remaining 95 percent of the economy outside of residential construction…”

§  IMF BEHIND THE CURVE – Jul 25, 2007 – IMF – “…The strong global expansion is continuing, and projections for global growth in both 2007 and 2008 have been revised up to 5.2 percent…”

Bankruptcy waves tend to follow times of indiscriminate high yield issuance

* Data provided by www.bankruptcydata.com, JP Morgan, Thomson Reuters and the Edward I. Altman-NYU Salomon Center

Flash Update: FT reports alarming rise in leveraged loans, especially Cove-Lite debt & PIK notes

This past Saturday (10/22/13) the Financial Times reported about the alarming rise in “cov-lite” loans in the leveraged loan market.  The Fed-induced  “ultra-low rates have made the loans for highly indebted companies white-hot in recent years as investors clamour for the higher yielding assets and corporates rush to refinance old debt.”  In 2013, the volume of leveraged loans written to date is on track to match or exceed the record set in 2007 just before the bursting of the credit bubble.  However, at the same time, the quantity of cov-lite loans within the leveraged loan market has actually doubled since 2007.

So the obvious question is: Has the underwriting quality kept pace even with 2007’s standards?  Do cov-lite corporate loans signal the next sub-prime debacle?  “Once the vast majority of leveraged loans are issued as cov-lite, few will be able to argue that only the strongest credits are getting the cov-lite treatment.  The trend has not gone unnoticed by regulators.” says the Financial Times. 

Yesterday’s Financial Times additionally reported that the issuance of payment-in-kind (PIK) toggle notes, allowing the company to pay lenders with more debt rather than cash, has surged in recent months.  There has been $9.2 B of PIK note issuance this year, already nearly 40% higher than last year and approaching 2008 levels.  32% of companies that issued PIK bonds during the bubble era defaulted at some point from 2008 to mid-2013, according to Moody’s. 

While cov-lite leveraged loans and PIK toggle notes may not in and of themselves represent the type of systemic risk to the economy as the sub-prime market, they could represent a significant trading opportunity and early warning sign for funds such as the Tradex Short-Biased High Yield Portfolio.

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

Flash Update: MBS tighten post weak Non Farm Payrolls (NFP) yesterday

Yesterday’s anxiously awaited September Payroll Report shows the change in non-farm payrolls (NFP) was weak at 148k vs 180k expected.  The Treasury curve flattened -8bps in yield on the longer end as one might have expected.  Mortgage yield spreads also tightened about -2 bps versus their hedges yesterday.  In terms of price performance, this equated to discount 30-year mortgages having rallied +30 bps in total return versus their Treasury hedges yesterday alone!

In total, the 30-year current coupon mortgage rate has tightened -10 bps in yield versus the treasury curve since the “no taper” decision by the Fed in mid-September and almost -30 bps since reaching their widest point in early July, after reacting to the Bernanke statement that tapering could begin later this year.  Clearly mortgages have been on an torrid run in the 2^nd half of 2013.  This is positive for our Liquid Real Estate Portfolio, particularly in the agency IO securities and other agency MBS relative value trades.

However several countervailing data points from yesterday might need to be considered as well.  The August change in NFP was revised upward by an almost equal amount as what the September NFP missed to the downside.  The headline unemployment rate also ticked downward to 7.2% from 7.3%.  The day-of-tapering will return once again and spreads will widen again.  The net take-away is that the mortgage “basis”, i.e. the yield spread between mortgages and Treasuries, remains highly data-dependent and range-bound.  We believe there remains excellent opportunity to trade the mortgage basis in this environment from both the long and the short side.  

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

Tradex Global Advisors Announces Jeffrey Trongone as President

Tradex Global Advisors Announces Jeffrey Trongone as President

Greenwich, CT, October 21, 2013 -- Tradex Global Advisors, LLC, an alternative asset management company, announced today that Jeffrey Trongone has joined the firm as President.  He will work closely with founders Michael Beattie and Richard Travia to continue the development of Tradex as a leading alternatives business offering niche investment products, trade specific opportunities and a disciplined business platform to investors.  Mr. Trongone joins the firm as a senior partner and will focus on all commercial activities.

“We are fortunate to have Jeff partner with us to ensure that we maintain the highest business and ethical standards in the industry.  Jeff is a seasoned business leader, consummate professional and skilled in all aspects of the hedge fund business.  Jeff will be instrumental in working with Tradex as we evolve from strictly a fund of hedge funds to expanding our single strategy hedge fund business,” said Michael Beattie. “He brings highly developed industry knowledge and deep relationships to Tradex,” added Richard Travia.

“I'm excited to join Tradex to complement the firm's unique strengths of developing timely and innovative investment products. The Tradex business model is exactly the vision that I believe is most effective for investors in the alternative asset class.  I believe that my business strengths will allow the Tradex Portfolio Managers to fully dedicate their time toward identifying opportunistic trades and emerging, niche hedge fund managers.  Michael and Richard have had a great deal of success in identifying the highest quality portfolio managers and strategies, while putting the interests of their investors ahead of all else.  In this industry, I believe investors are our partners and not just clients, and I know Michael and Richard feel the same way,” said Trongone.

Before joining Tradex, Mr. Trongone was CEO and founder of Malbec Partners, a hedge fund multi-manager platform sponsored by BNP Paribas. Earlier in his career he was COO at hedge fund Third Point and prior to that CFO and Managing Director of JP Morgan's asset management business among other well respected investment firms. Mr. Trongone began his career at KPMG and is a graduate of Fordham University. He resides in Armonk, NY with his family.

About Tradex Global Advisors

Tradex Global Advisors, LLC (TGA), headquartered in Greenwich, Connecticut is part of The Tradex Group of investment companies.  TGA manages Fund of Hedge Funds and internally managed Hedge Funds, including their recently-launched short-biased high yield and a liquid real estate strategies.  TGA was founded in 2004 by Michael Beattie and Richard Travia and focuses on innovative and niche investment products and strategies for its investors.  With its targeted focus, TGA seeks to identify uncorrelated and sustainable investment outperformance (“alpha”) across market cycles in all of its products.

Contact Jeffrey Trongone, 203-863-1518
This press release is for informational purposes only.
Source:  Tradex Global Advisors, LLC

FLASH Update: MBS Responding Well to Debt Settlement

Today we are seeing MBS continuing their tightening, which began yesterday after an early rumor spread of a settlement in Congress on the debt deal.  Current coupon mortgages have tightened about 4 ticks (0.125%) against their treasury hedges at midday, after tightening by a similar amount yesterday.  The treasury curve is also rallying and flattening as well.  Curve flattening dynamics are typically good for mortgages and other fixed income spread products.  We expect the current environment to continue to be constructive for agency MBS securities. 

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

Flash Update: The Financial Times reports buyout debt returns to pre-crisis levels in the US

Typically in the late stage of any boom market there is an over-extension of debt and leverage.  In a research piece we distributed yesterday, we showed how leverage in the high yield sector, as defined by the Fitch Credit Services, has reached levels far outstripping pre-crisis levels. 

In an unrelated piece yesterday, The Financial Times reported that private equity funds have tapped the “buoyant credit markets” to levels not seen since the boom years before the financial crisis.  As reported by FT, at September 2013 levels, the debt component of US private equity deals has reached 5.3 times EBITDA.  “This is the highest ratio since 2007, when the average debt proportion reached 6 times EBITDA, and surpasses the 2006 level of 5.1 times EBITDA.  Six years ago, such ratios were symptomatic of a credit bubble,” writes the Financial Times.  “(This is) starting to lift valuations artificially.”

However, we note that while PE firms appear to be leaning heavily on leverage to drive the deals of today, they are merely approaching pre-crisis levels.  By comparison to managers of high yield companies, PE dealmakers appear to be almost judicious in their use of leverage.  By comparison, in our research note, we see that the high yield sector has already dramatically outstripped pre-crisis levels.  For example, as measured by Total Debt to Market Capitalization, leverage has now reached 113%.  Ten years ago this ratio was 54% and rose to become 78% at the height of the debt crisis in 2008-2009.

While the data shows their use of leverage did pull back in 2010 and 2011, high yield companies appear to have short memories.

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

Flash Update - The US High Yield Market - A Prescription(Rx) for Trouble

A Prescription (Rx) for Trouble

High yield issuers’ profitability is again coming under pressure just as it had in 2007-2008.  However, what is even more alarming is that these marginal credits have ramped up their balance sheet risk (i.e. leverage ratios) to levels far in excess to what existed during the 2007-2008 credit crisis in an ill-advised effort to try to maintain earnings per share.  History (and common sense) tells us this is a prescription for disaster.

Also of note, even within a limited population such as the Fitch High Yield Credit universe (67 names), we can see there is significant dispersion in key fundamentals.  Clearly, within the even larger universe of the entire high yield population (approximately 1250 names) significantly greater dispersion can be expected to exist, offering even greater investment opportunities for skilled managers to add value through superior security selection. 

Profitability                                                                                                                Figure 1

As can be seen in Figure 1, the profitability of the typical (i.e. median) high yield company dropped significantly in 2008 to -0.99%.  However the equally-weighted average (i.e. mean) high yield issuer experienced a much greater drop to -7.78% in 2008.  This illustrates that there are significant outliers with respect to profitability in the Fitch universe of high yield issuers. 

Importantly, more recently we can see that the profitability of both the median issuer and average issuer has again begun to drop off in 2012 as well.

Balance Sheet Risk (i.e. Leverage)                                                                            Figure 2

In figure 2 we see that after the credit recession of 2007-2009 the leverage ratio for both the median and the mean high yield issuer pulled back by 2010.  However, today we see these issuers are taking on a lot more balance sheet risk (leverage) recently - precisely at a time when profitability has been coming under pressure.

Conclusion / Opportunity

The high yield sector is overvalued and leverage is increasing precisely when profitability is deteriorating.  This offers a manager who focuses on the worst 100 or 200 credits of the entire high yield universe a very asymmetric return profile from the short side.

Figure 1.

*Source:  Fitch

Figure 2.

*Source:  Fitch

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

FLASH UPDATE: The morning after the government shutdown in the Treasury and MBS markets

A somewhat tepid response today to the governmental shutdown with Treasuries selling off slightly (~2bps).  Mortgages have tightened, especially in the discount coupons and longer maturities (i.e. 30 years versus 15 years) as expected.  However, all-in-all, the response is muted perhaps reflecting the market’s perception that the government shutdown will be short-lived and a relative non-event.

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global