It is very clear that the models
used to determine the ability of a HY company to repay its debts are severely
broken. There have been many instances of incorrect recommendations made
based on historical data and criteria. In numerous cases, a Buy or Hold
recommendation was just wrong. (See the case study on Mirabela Mining
Ltd. that we are putting out this week on our blog. The bonds were still
trading at par earlier this year after the equity had fallen 93%! The company is now in bankruptcy. Clearly someone’s model was
wrong.)
As
in the late stages of the housing boom, underwriting standards in the corporate
credit markets have loosened as the offer continues to get lifted at higher
prices for CCC credits. Today more than 50% of the new issuance for
senior bank debt is cov-lite, approximately double what we saw in the previous
cycle’s peak (2007). In such a lax underwriting environment, with high
yield issuance near record highs and spreads near all-time tights, the only
question that remains is ‘When?’ When the liquidity stops (or even
as it “Tapers”), the weak underwriting and excessive leverage in “specific” HY
companies (150-200) will force a wave of defaults, potentially larger than the
normal 50% ratio. We have a structure in place that allows us to wait for
the music to stop.
Tradex Global Advisory Services, LLC
investorrelations@thetradexgroup.com
203-863-1500
@Tradex_Global
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