Market Timing on Debt

The historical “rule of thumb” is that markets are rational. This is likely true over some period of time, but not in the short run.

A recent article in the WSJ (more like a blurb, on the back page) called “The Big Number” described the current situation with junk bonds.

Yield hungry investors are making the bond market a welcoming place for even the lowest rated borrowers. The average yield paid by new triple-C rated issuers (i.e. “junk”) of corporate bonds in the third quarter hit a record low.

The current yield on new CCC bonds is 9.05%, down from 10.65% in the second quarter of last year. This is a decline of 18% in about a year, which is a giant decrease for a company considering re-financing.

In addition to being able to sell debt at the lowest rates in years, these highly leveraged firms are also able to find buyers for their debt (i.e. the market is liquid).

When the market freezes up, as it did in 2008, there are two main impacts – 1) the rates that everyone pays for financing in the short term move up sharply 2) there is little financing available for those that don’t have the strongest credit. In practical terms, #2 means that if you need money, it will cost you very dearly such as when Goldman Sachs had to borrow from Warren Buffet at a 10% preferred stock issuance.

While it is very difficult to determine the right time to buy and sell, there is no doubt that “market timing” is of incredible importance. If you have a highly leveraged company, these low rates and many yield hungry buyers willing to lend to you means that you can retire very high cost debt, load up on lower cost debt, and roll out maturities for many years, buying your company valuable time in case there is a recession or business downturn.

Today is literally the opposite point of time in terms of market timing from when Goldman Sachs was forced to pay 10% rates to Buffett; today even the lousiest company (in terms of credit ratings) can get funding cheaper than that (9.05%, per this article). This doesn’t mean that rates won’t still fall – if I could predict that I’d be on an island somewhere – but it does show the amazing difference in market conditions that just a few years made, without the economy itself changing in any substantive manner.

Who is buying all of this? Right now your bank account and CD’s effectively pay almost zero, and US government debt 10 years out is 1.6%. Thus for someone who wants income, an investment that pays 9.05% LOOKS a lot better than under 2%.

The flip side of loaning to the most highly leveraged, lowest rated companies, is risk. Risk can be business risk or their continued ability to find low rate financing (liquidity).

On a market timing basis, this is the best time for these sorts of companies.

Cross posted at Trust Funds for Kids

5 thoughts on “Market Timing on Debt”

  1. I wouldn’t touch that stuff at these prices. If the market ever snaps back to “normal” i.e. 10 yr T-bonds at 5%. You will loose a very large chunk of your principle.

  2. Michael Milken grew very rich by trading junk bonds. These things are not for the ‘buy and forget’ set. Junk can be umdervalued in much the same way as a liberal politician can be undervalued.

    Every dog has its day and trading junk requires finding the silver lining that even the darkest cloud possesses.

    Sometimes a company that sells junk gets healthy and gets its credit rating improved.

    Trading junk is a full time, 80 hr/week job.

  3. For the first time in 4 years a NYSE listed partnership of levered loans that I’ve held traded at or slightly above its book value price. So after four years last week I sold.

    Levered loans are syndicated bank loans to already debt heavy companies at a higher interest rate than investment grade loans. They are quite risky, and their location in a company’s capital structure is critical unless you enjoy playing Russian roulette.

    This partnership’s portfolio of glamorized junk trades at 1.02x book value today. By way of comparison:

    Bank of America trades at 0.45x BV

    JPM is at 0.84x BV

    Citibank is at 0.54x BV

    Goldman Sachs is at 0.84x BV

    That was what I needed to see to realize it was time to take profits.

    A good tool to track the performance of these loans is here;

    Pre Lehman Bros. this index never traded below 95 cents on the dollar. In the immediate aftermath it touched as low as 67 cents. Currently it’s at 96 cents.

  4. It’s a good time for a highly leveraged company to refinance. Maybe it’s also a good time for investors to buy that debt, but somewhat risky. What’s really risky is buying long-term treasuries. One way to play it might be by owning diversified corporate debt and treasury puts. Or just keep buying and rolling OOTM puts.

  5. A friend of mine described credit market condition as “we aren’t back to 2006 but pretty close.” For a while it was just bank loans, now it’s everything. Hmmmm, maybe those excess reserves will finally work their way through the system.

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