Unlocking the High Yield Bond Market Martin Fridson CEO FridsonVision LLC Presented to the Midwest Finance Association March 16 2013
Is There a Bubble in High Yield Bonds? 2
Exhibit 1 Yield-To-Worst : High Yield Master II Index and Five-Year Treasury Index Monthly, December 1996 – January 2013 25 20 15 Percent High Yield Universe 10 Five Year Treasuries 5 0 Dec-96 Jun-97 Dec-97 Jun-98 Dec-98 Jun-99 Dec-99 Jun-00 Dec-00 Jun-01 Dec-01 Jun-02 Dec-02 Jun-03 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Source: BofA Merrill Lynch Global Research, Used with Permission 3
Exhibit 2 Option-Adjusted Spread : High Yield Master II Index Monthly, December 1996 – January 2013 2500 2000 1500 Basis Points OAS 1000 Mean OAS (601) 500 0 Source: BofA Merrill Lynch Global Research, Used with Permission 4
Exhibit 3 Global Default Rate Percentage-of-Issuers Basis Annually, 1981 – 2012 12 10 8 6 Percent 4 2 0 Source: Standard & Poor's 5
Exhibit 4 New Issuance vs Net Increase in Outstanding U.S. High Yield Bonds, 1999-20121 400 350 300 250 200 $Billion New Issuance 150 Net Increase 100 50 0 -50 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sources: BofA Merrill Lynch Global Research, Bloomberg 6
Points Basis Exhibit 5 Sources: BofA Merrill Lynch Global Research, Bloomberg, S&P, Federal Reserve -400 -300 -200 -100 100 200 300 400 500 600 0 12/31/1996 Monthly, December 1996- January 20133 5/31/1997 10/31/1997 3/31/1998 Actual Spread minus Fair Value 8/31/1998 1/31/1999 6/30/1999 11/30/1999 4/30/2000 9/30/2000 2/28/2001 7/31/2001 12/31/2001 5/31/2002 10/31/2002 3/31/2003 8/31/2003 1/31/2004 6/30/2004 11/30/2004 4/30/2005 9/30/2005 2/28/2006 7/31/2006 7 12/31/2006 5/31/2007 10/31/2007 3/31/2008 8/31/2008 1/31/2009 6/30/2009 11/30/2009 4/30/2010 9/30/2010 2/28/2011 7/31/2011 12/31/2011 5/31/2012 10/31/2012 Deviation - 1 Standard Deviation + 1 Standard
Conclusion: • High yield is extremely rich because Fed’s low -interest rate policy is driving investors into risky assets. • But buying is not driven by Greater Fool Theory 8
Has New Issue Boom Trashed Credit Quality? 9
Exhibit 6 Triple-C as Percent of High Yield Universe By Face Amount, 1996 - 20122 35 30 25 20 Percent 15 10 5 0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: BofA Merrill Lynch Global Research, Used with Permission 10
Conclusion: • Credit quality deterioration of high yield universe has been modest • Caveat: Seasoning of new issues also matters • Ratings mix changes driven more by upgrading and downgrading than by new issuer quality 11
Is LBO Volume about to Surge? 12
Exhibit 7 High Yield Spread versus LBO Volume U.S., Annually 2001-2012 700 600 500 400 Basis Points 300 y = 577.23e -0.003x R² = 0.5311 200 100 0 0 200 400 600 800 1000 1200 1400 Option-adjusted spread, weekly average (bps) Sources: BofA Merrill Lynch Global Research, Used with Permission, Bloomberg 13
Conclusion: • Modest rise in LBO volume likely in 2013 • Credit implications moderately unfavorable 14
For the Past Century Beginning Yield Has Controlled Annualized Return over Next Four Years 15
Exhibit 8 Quadrennial Promised and Realized Yields on Low-Rated Bonds 1912-1943 25 20 15 10 Realized y = 2.1367x - 13.655 Yield (%) R² = 0.6011 5 0 -5 -10 0 2 4 6 8 10 12 14 16 18 Promised Yield (%) Source: W. Braddock Hickman, Corporate Bond Quality and Investor Experience (Princeton University Press, 1958) 16
Exhibit 9 Trailing-Four-Year Periods Beginning 1981-2009 Yield-to-Maturity and Annualized Return 25 20 15 Annualized 10 Four-Year y = 1.5925x - 9.352 Return (%) R² = 0.6875 5 0 0 5 10 15 20 25 -5 Beginning Yield-to-Maturity (%) Note: High Yield 100 (1981-1984), Master (1985-1987), Master II (1988-2009) Source: BofA Merrill Lynch Global Research, used with permission 17
Conclusion • Expected return for 2013-2016 is 1.40% annualized • Something exceptional must occur for high yield to earn the coupon over that period 18
Contact Information Martin Fridson CEO FridsonVision LLC 1-917-403-9194 marty@fridson.com
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