The Debt Market

Over the last week or so, I have received a number of emails from readers asking my thoughts on the current debt market. Most of these questions really refer to the state of the primary debt market so I will focus on that for this post specifically. The secondary is a whole other issue, but for now, let's try to dig in and see what is happening in the primary debt market.

Before we begin, we need to segment the market into three baskets. These baskets are quite broad obviously, but for the time being will serve us fine:

1. The high yield bond market
2. The investment grade bond market
3. The levered loan market

We participate in all three markets. Last week, AMG reported their mutual fund flows for the week ended February 10th. Here are the relevant statistics:

High Yield

• Outflow of $984M this week
• YTD inflow of $2,246M

Bank Loans

• Inflow of $195M this week
• YTD inflow of $1,691M

Investment Grade

• Inflow of $692M this week
• YTD inflow of $24,070M

So, the only real outflow was the weekly data for high yield. And empirical that's how it feels in the market right now. We have seen a lot of new deals being postponed or pulled in the high yield market. And the high yield deals that did get done are definitely trading weaker. For example, Freescale issued a 10.125% bond last week, which priced at par. On the 9th of February, after the deal was closed, I saw a market of 100.75/101 (i.e. the dealer will buy from you at 100.75 and sell to you at 101). The last run I saw on Friday was 98.625/98.875.

Now, that might not seem a lot to readers, but most new issues were trading at least a point or two above the break up through January. That, in tandem, with quite a few new issues being pulled (Songa, Bombardier, etc) spells some trouble for the high yield market. You also have exogenous events like Travelport pulling their IPO which sent bonds down 6 or 8 points depending on the tranche, and you get even more skiddish.

Why is this occurring? I couldn't give you a specific reason but my guess is that investors are ratcheting up risk premiums in light of what is going on with the PIIGS. Higher credit spreads are needed when everything is riskier right?

Investment grade is another story. To me, it seems like the IG market, despite the index nearly trading back to par (the IG13's got as low as the mid 70s in January) still feels pretty strong. Obviously PIIGS risks have sent spreads leaking higher, but new issue's are still trading quite strongly. Kraft did a big deal last week (had to relaunch it 5 bps back) and priced the 16s at 190 over. They went out on Friday wrapped around 178. And yes, maybe Kraft issued well wide to get a strong syndication, but quite a few of the new issue high grade companies are trading well through new issue prices.

I'd have to say the same for senior secured bank debt. SSCC's new term loan is trading above OID. Six Flag's exit facility is trading a little bit weaker, but not materially. Some of the smaller new issues in the bank debt market are trading quite well. From everyone I talk to in the street, CLO's still have money to put to work with so much paper being refinanced into the senior secured bond market and their reinvestment windows not expiring until 2012-2014 depending on the vintage.

So net/net? Investors are asking for more risk premium and are allocating more capital to safer asset classes (high grade and levered loans) at the expense of riskier assets like high yield. One could also argue that high yield had such a monstrous run that something had to give. Most of the people I talk to were de-risking going into the end of the year and even through January. I do not have a sense whether the street is long/short right now - everyone is playing their cards pretty close to the vest. Obviously IG is the home run trade if the curve tightens from here as investors seek the safety of the U.S. treasury relative to risk assets. Unless of course credit spreads widen significantly on a double-dip recession. Like I noted in a previous post, I wouldn't want to ratchet up the risk at this point in the cycle - lots of us made money in 2009, and want to conserve our investors capital when better, more juicy opportunities arise, possibly in the 3rd or 4th quarter of this year.