In response to Bubblicious Debate: Greenspan Says “Bond Bubble About to Break”, No Stock Market Bubble, reader AC wants to know how to track it.

Hi Mish,
how can I track/spot Junk bonds yields?
The bubble sounds very close to the top, with bears throwing in the towel, and “new normal” thinking back in vogue.

Bond Yields

Moody’s Baa is its lowest investment grade, one step above junk.

Baa yields are at a record low. The BofA Merril Effective High Yield is near record lows. Euro-denominated junk bond yields are at a record low.

Junk bonds yields are priced as if the Fed and ECB can permanently prevent corporate defaults.

HYG Junk Bond Index

Record Issuance of Covenant Lite Loans

On May 23, Barron’s reported Weaker Loan Terms Could Mean Lower Future Recoveries.

Moody’s Analyst Julia Chursin comments:

“After three years of record issuance, cov-lite loans now account for the largest share ever of the US leveraged loan market, while at the same time debt cushions below first-lien cov-lite loans have fallen dramatically. This deterioration portends lower investor recoveries in the next default cycle.”

If the issuer goes into bankruptcy, the lack of a debt cushion below the first-lien notes can mean lower recoveries, Moody’s finds in a new report published Tuesday. The report makes these key points:

  • With cov-lite loans constituting ¾ of the new institutional loan issuance in 2016, debt cushions below first lien cov-lite loans have fallen dramatically in recent years, from about 33% for loans issued before the credit crisis to about 22% last year.
  • The structure of loans, crucial to determining recovery rates, has deteriorated as cov-lite loans came to represent the majority of the syndicated loan market.
  • Moody’s analysts forecast recoveries on recently rated first-lien loans, both with and without maintenance covenants, at just over 60% — significantly lower than the 85% long-term average recovery for first-lien secured bank debt.
  • Cov-lite borrowers default at the same rate as the broader spec-grade universe, with a firm analysis showing the 3-year average cumulative default rate of all cov-lite loan deals between 2005 and the first quarter this year dropped from 18.3% to 12.3%, a percentage nearly even with the rate for all US spec-grade corporate debt issuers (12.6%).
  • Of 54 cov-lite defaults analyzed, prepackaged bankruptcies and DEs are still heavily represented in cov-lite defaults, explained by the presence of PE sponsors – 57% of the analyzed population being owned by a PE firm at the time of their default.

Toggle Bonds

Toggle bonds, also known as Payment-in-Kind (PIK) bonds allow the borrowers to pay interest, not in cash, but with more bonds.

On September 8, 2016, Bloomberg reported Red-Hot Market Spurs Risky Bonds That Allow Interest Delays.

The bond market is getting so hot that it’s fueling a surge in debt deals allowing companies to defer interest payments.

Just a week in, September is already on track to become the busiest month for so-called payment-in-kind toggle notes that let companies pay coupons with more debt, according to data compiled by Bloomberg. Ardagh Group SA, a Luxembourg-headquartered packaging company, sold $1.72 billion of the securities. German auto components maker Schaeffler AG is poised to sell 3.59 billion euros ($4.05 billion) of the notes on Thursday, more than 1 billion euros than initially planned, which would make it the largest PIK issue ever, Bloomberg data show.

Investors desperate for high yielding assets are cutting companies more slack and accepting weaker debt terms because central bank stimulus has sent yields on $11.4 trillion of securities below zero. Average yields on junk-rated bonds slumped to a record low in Europe and globally are dropping toward unprecedented levels reached two years ago, according to Bloomberg Barclays bond index data.

PIK debt is often issued at the holding company level, which makes the notes riskier because they are one step removed from the operating company. Schaeffler is selling its notes through its holding company.

The debt became popular before the financial crisis because private equity firms used it to fund their take-over deals without the need to use up cash for coupons. More recently, it has been increasingly used in restructurings to take pressure off companies’ cashflows.

“No Irrational Exuberance in Stocks”

“There is no irrational exuberance that I can see. In fact, it is just the opposite at this stage.”

Fed Sponsored Bubbles

The junk bond bubble (asset bubbles in general) is courtesy of interest rate suppression policies of the Fed and ECB.

I find it ironic that Greenspan speaks of a “bond” bubble” in Treasuries, totally oblivious to the real bond bubble in junk.

Neither the Fed nor the ECB sees the bubbles they have created. Their mission is not to spot bubbles or prevent them. Their mission is to bailout the banks after the bubbles they create implode.

I offer this bit of advice on Greenspan.

Related Articles

  1. Bubblicious Debate: Greenspan Says “Bond Bubble About to Break”, No Stock Market Bubble
  2. Central Banks Puzzled as Global Inflation Hits Lowest Level Since 2009: Solving the Puzzle
  3. “Idiosyncratic and Transitory Factors” Holding Down Inflation: New Definition of Transitory

For a detailed look at the stock market bubble, with thanks to John Hussman, please see Median Price-to-Revenue Ratio Higher in All Deciles vs 2007, 90% vs Dot-Com Bubble: THE Choice

Mike “Mish” Shedlock