Happenings in the Credit Markets - January 2012

So, things change fast apparently.  A little over a week ago I wrote that: "On the credit side, things feel pretty customary on the new issue front. High yield and bank debt deals are not 3-5x oversubscribed like they are in "go-go" markets.  There has been a pretty good amount of supply but these deals are not flying off the shelves"  


Well, I take that back: Deals (some of them quite suspect) are flying off the shelves.  Many of deals priced this week in high yield land were 5x+ oversubscribed.  Some marginal issuers, brought by marginal dealers / agents, were also getting done but more akin to 1-2x oversubscribed.  One of the hottest deals in the market, which I particularly liked at both original and (less so, but still interesting) final pricing was the Eastman Kodak DIP.  The final pricing was L+750, 1% floor, issued at 98.   Originally it was talked in the 96-97 range at L+850 with a 1.5% floor.  The deal was nearly 10x oversubscribed and probably right so at that initial pricing.  The deal is now trading at 100.5-101 with good 2-way markets


What concerns me though, is the feeling of rumbling of risk taking percolating in the market.  We're no where near "All hands on deck: sell everything" in terms of where I feel risk is priced.  But initial deal pricing is tightening in dramatically, bankers are increasing the size of deals (always to the detriment of creditors), and cuspier and cuspier borrowers are coming to the market. It feels like many marginal issuers have been waiting on the sidelines for their window to issue into a hot market:  This is feeling like that sort of market.

In early December, I wrote 

"But with everyone painting a doomsday scenario, I'm not quite sure that will happen.  The market is NOT ready for a sustained bullish rally - too many investors are flat or are running with a low gross exposure.  The only thing that I've known to be true in macro prognosticating: The market will move in a way that hurts the most people at anyone time.  If everyone is long, it will go lower.  The pain trade today, surprisingly, is up. "

Since then everything is up except: Credit, distressed, equities, Italian bonds, etc.  As I am oft to do, I point to Howard Marks' view of the risk spectrum as a pendulum.  I visualize this as 5 points on a pendulum:

1. When the world is extremely bearish and you can buy most things indiscriminately for a sizable gain.  At these times, your friends call you a lunatic / maniac and are one of the few buyers out there (November 2008 is the prime example)
2. When the world is bearish, there are more buyers, and risk assets will still produce a better than commiserate return for the risk underwritten
3. When markets are fairly valued and the bulls and bears are equally on the side of the fence.  At this point, investors are taking return for the exact amount of risk  
4. When markets and the world are bullish, assets are becoming fully valued, and really the best strategy to employ here are event driven ones like merger arbitrage or liquidations (LBHI) that remove market risk from the equation.  Here you start to see short squeezes
5. When markets are fully valued, everyone is a buyers (except for you hopefully), and you are playing with fire by buying any risk asset

We moved very quickly from point 2 which I felt represented a lot of the 3rd /4th quarter of 2010 to point 4 (or maybe a 3.75 if I was exact) which I would characterize now.  We're no where close to 5 - there are still too many bearish people out there but we are at a point where I am definitely a better seller of risk assets and am instead focusing 100% of my time on special situations (I would characterize the EK DIP as such, as well as a few other distressed situations).


The high yield market, as measured by the CS HY Index, is up 2.62% YTD.  CCC/Split CCC is up 5.75% year to date(!).  Yesterday was one of the stronger days I can remember in high yield with buyers of everything and very few cash sellers.  It felt like a panic really to be long risk, especially down the credit spectrum.  High yield recorded $1.9b of inflows last week which I am sure will push prices up higher.   As inflows push bids up, the HY market shows higher returns, which makes retail investors (read: dumb money) chase returns further propagating the cycle.  With the Fed on hold until 2014, the appetite for yield seems insatiable right now.  


I am generally early (like most value investors) so do not take this post to mean I am sitting on my hands waiting for the market to turn.  I continue to do work on special situations (in and out of bankruptcy), and see value in certain structures (I am still working through Petroplus).  In fact, one of my largest positions (at least in my personal account) is a bankrupt equity that I plan to post on the DDIC sometime in the next few weeks with a possible 5-10x return with minimal downside.


The one word to describe my sentiment: Cautious.