High Yield Record

Over the past few days, I read a number of stories about high yield debt issuance for March 2010 being an all-time record. From Bloomberg:

March 29 (Bloomberg) -- Junk bond sales reached a record this month as rising profits and record low Federal Reserve interest rates foster lending and investment to the lowest-rated borrowers.

Companies worldwide issued $38.3 billion of junk bonds in March, passing the previous high of $36 billion in November 2006, according to data compiled by Bloomberg. Yields fell 0.95 percentage point to within 5.96 percentage points of government debt, the narrowest gap since January 2008, Bank of America Merrill Lynch index data show.

This is “an almost ‘Goldilocks’ environment for leveraged credit markets,” JPMorgan Chase & Co. analysts led by Peter Acciavatti, the top-ranked high-yield strategist in Institutional Investor magazine’s annual survey for the past seven years, said in a March 26 report to the bank’s clients.

Sales soared as investors plowed a record $33.6 billion into speculative-grade funds this quarter, according to Cambridge, Massachusetts-based research firm EPFR Global. Bonds of Stamford, Connecticut-based Frontier Communications Corp. and Consol Energy Inc. of Pittsburgh, which sold a combined $5.95 billion of debt last week, rose about 2 cents on the dollar to 102 cents.

That’s a turnaround from February, when companies canceled sales at the fastest pace since credit markets began to freeze in 2007 amid concern that the inability of European governments to trim their budget deficits will threaten a global recovery.

In February, I wrote a post about the weakening of the high yield market. This month feels the exact opposite. 95% of deals are well oversubscribed (similar levels in the loan market). From a bottom's up perspective, it is becoming increasingly hard to find value in the corporate space. It feels sort of like Jan/February 2007 when you would look out on the primary market/second market and know that it couldn't sustain itself - we would always ask the sell side: "What stops this train?" And most of them said, "We just don't see it stopping..." How did that work out for you?

Unfortunately, the momentum is self-fulfilling prophecy in an asset class like high yield. People read about returns, throw money into the asset class, bid it up higher, more articles, more capital, rinse/repeat. I did a poll of DDIC members on their expectations for the 2010 return on high yield. Over 80% believed it would be less than a 5% total return. Is that attractive? Maybe if you are comparing it to sub 50 bps savings accounts, and still quite low treasury yields.

As a contrarian, I am usually early leaving a hot market. When I read article after article about how great the high yield market is, I become more tepid about allocating capital to the space. Am I short? Not terribly - CDS on certain IG names looks very interesting for the optionality. Am I completely out of the market? Absolutely not - There are still a few interesting distressed debt, post-re org equities, and merger arbitrage opportunities that have offer a sufficient upside, with limited downside, combined with a catalyst. That is still where we like to allocate our capital.