Paper: "Analyst Promotions within Credit Rating Agencies: Accuracy or Bias?"

Ha!:

We examine whether credit rating agencies reward accurate or biased analysts. Using data collected from Moody’s corporate debt credit reports, we find that Moody’s is more likely to promote analysts who are accurate, but less likely to promote analysts who downgrade frequently. Combined, analysts who are accurate but not overly negative are approximately twice as likely to get promoted. Further, analysts whose rating changes are more informative to the market are more likely to get promoted, unless their ratings changes cause large negative market reactions.

Credit Spreads Suddenly Wider $HYG

This is a dramatic widening in credit spreads. And from the look of the chart, the trend in spreads is very bullish (wider).

That has a lot of implications. Mood shift. Flight away from risk to Treasuries. The LBO bid for companies falls or goes away entirely.

A correspondent writes in,

"I believe that most market observers have forgotten that in past rate cycles market driven rate increases always lead Fed increases. Here we have the junk bond market beginning the tightening well in advance of the Fed. Quality spreads will widen across the curve. Watch CDO issuance collapse as the risky tranches become hard to place. Watch for private equity deals to dry up. And what dry powder does that Fed have to stop it? Is the next QE going to purchase lower rated CDO tranches and junk bonds instead of treasuries and mortgages? Would a revived QE directed at treasuries do anything other than exacerbate the flight from junk and risk to safe and upwardly trending treasuries? This is how collapse starts as it moves from the fringes of the credit market toward the 'safe and secure' center."

More From "Vienna Capitalist"

Another good post, about mining:

"According to Austrian Business Cycle Theory (ABCT), during a credit boom those sectors that are most removed from ultimate consumption benefit the most during a credit boom. Due to the long-term nature of these projects interest cost is a relevant cost component, which gets lowered during the boom and hence ignites heavy activity. Needles to say: these sectors also disproportionally fall during the slump.

Now, there are few things further removed from consumption than mining. The credit boom in this case is China’s lending binge and the most remote sector impacted by the binge is the mining industry, which provides the main input for all that steel that goes into the empty skyscrapers. And in Australia’s case the whole economy is a derivative of the mining boom. China is the main reason why there has not been a recession in Oz for the past 20 years – not some superior central bank management or 'growth model.'"

He's short AUD/USD.

Thoughts on Private Equity and High Yield Bond Duration in Latest Horizon Kinetics Quarterly Letter

[pdf]

"If one reviews some broadly representative bond indexes, like the iShares Core Total U.S. Bond Market ETF (AGG), which emulates all the investment grade bonds in the United States, one will find that the average maturity is not much longer than six years. Or, taking the iShares iBoxx $ High Yield Corporate Bond ETF, the average maturity is just over four years.

In other words, even though there are buyers of 30-year bonds, looking at the bond market as a whole, it is clear that very few are interested in taking duration risk. Everyone is aware of the interest rate risk, and they are preparing for it. Bond buyers, especially those taking credit risk, certainly do not want to add duration risk.

However, there is one group taking the risk, but it just does not realize it. In that group are those institutions — and they are only institutions — that are placing large amounts of money in private equity. They think they are lowering risk. They are removing money from publicly traded equity, and even bonds in some cases, and placing it in private equity.

Of course, private equity is borrowing the money because it is only private equity in name. A more functionally accurate term would be leveraged equity. The idea behind buy-out private equity investing is to find a suitable public company, pay a control premium for it, and then bring it private with an extraordinary amount of debt. If the maturities on those borrowings are short (and, unlike the historical norm, there is much less availability of long-term high-yield lending to match the extended workout periods ordinarily required for private equity) and if interest rates rise, then the refinancing risk is entirely on the private equity investor. The bond buyer, assuming the company remains solvent, is going to get a higher coupon; the private equity investor is going to pay the higher coupon."

Subprime Auto Loans

"In the market where auto loans to people with spotty credit are bundled into bonds, the difference in yield between the lowest-rated securities and the safest has narrowed to the least since August 2007"

Credit Spreads Lowest Since October 2007

“The bottom line is that people have a lot of cash, and there’s a willingness to put it to work,” Mish said in a telephone interview. “I’m not saying that’s the prudent thing to do, but irrespective of the return forecast we have for next year, there’s a significant feeling that people need to earn more than zero.”

“Weaker credit is traveling down to smaller companies that ordinarily would not have this kind of leverage.”

A correspondent sends a link to "A New Credit Boom" in the NYT.

Pay in Kind Bonds

When you think about it, buying a bond that can pay coupons in more bonds rather than cash is insane. Right at the moment (coupon default) when you would want to swoop in and preserve collateral, you've given a debtor lots of extra leash.

WSJ: "Buyout Firms Throw Toggle"

PIK bond deals are back,

"A Precrisis Debt-Financing Tool Resurfaces in Neiman Marcus Deal... Buyout firms are pulling some risky debt-financing levers that were big hits during the boom years before the financial crisis—the latest example: so-called pay-in-kind, or PIK, toggle bonds."

Buying a PIK bond is a hilariously stupid idea. Right when the company gets in trouble - and the economically sensitive and leveraged companies that do PIK deals are eventually going to be in trouble - their leash gets lengthened instead of shortened. You'd be surprised how hard it is to shutdown and liquidate an insolvent company. Don't add to the delay.

PIK Toggle Deals - A Credit Market Peak?

A correspondent writes in,

"Based on how many PIK toggle deals I have seen price in the last 90 days...the end is near. Can't wait to see the retail crowd try and hit the bid on their floating rate funds/products all at once.  You know the ones that are being sold hand over fist as protection against 'rising rates'."

LCD News tweets about a pay in kind deal priced today by ConvaTec. Based on the prior two years' interest coverage ratio, I have decided to pass.

Rite Aid Debt Deal ($RAD)

Rite Aid issued debt this week at 6.75% and there was so much demand the offering was doubled to $800 million.

The most recent fiscal year, their interest expense was $515 million and their operating income before interest and taxes was $647 million (coverage ratio of 1.25x). For the past three fiscal years, their operating income was $832 million and their interest expense was $1.6 billion.

Like all the chain drugstores, they make almost all of their money filling prescriptions.

Another sign of a credit market top.

Barron's: "Another PIK-Toggle Bond Sighting To Pay A Shareholder Dividend"

Bearish note on PIK-toggle deals, written on May 21 of all days.

"Just in case it was unclear where in the credit cycle we are these days, have a look at the high-yield bond market and the sort of products it’s churning out today. Namely, we’re seeing a lot more so-called PIK toggle bonds. The 'PIK' part stands for pay-in-kind, meaning the company can make interest payments to bondholders not in cash, but in the form of – wait for it – more bonds. And the toggle part means that the company has the choice to make the payments in cash or in more bonds."

Subordination And Intercreditor Issues

Useful links:

*Subordination And Intercreditor Issues
*METHODS OF OBTAINING PRIORITY OF PAYMENT OVER COMPETING CREDITORS

A Market in Need of Disruption

Bond trading:

The trading here has resisted automation because companies that only have one stock have many different varieties of bonds, each of which carries its own price. Banks have found trading these bonds profitable because they have greater leeway over the pricing than if they traded in a market with transparent prices.

Another Preferred Stock: PetroQuest Energy Inc., 6.875% Series B Cumulative Convertible Perpetual Preferred Stock ($PQ, $PTQEP)

The PetroQuest Energy Inc., 6.875% Series B Cumulative Convertible Perpetual Preferred Stock, which currently trades at ~$34 (68% of par) to yield roughly 10 percent. Conversion price is $14.52, making parity $9.87 vs the current common share price of $5.31.

They have operations in Oklahoma, Texas, the Gulf Coast Basin, Arkansas and Wyoming and MRQ production was roughly 58% oil and NGLs by revenue. There's a May presentation [PDF] you can read.

Market cap is $330 million. There's $10 million in bank debt and $150 million in bonds that trade at a premium to yield 8.9%. The preferreds have face value of $74.75 million. Enterprise value is $565 million and EV through the preferreds is $235 million.

The MRQ EBITDA was roughly $20 million, or $80 million annualized, which gives EV/EBITDA of 7x and Debt+pref/EBITDA of only 3x.

Management owns 12% which is pretty good for a small E&P, and institutions own an additional 77%.

Companies with Distressed Bonds and Non-Zero Market Caps

Name	Ticker	Market Cap	Coupon	Maturity	Dollar Price	YTM
NETWORK EQUIP TECHNOLOGIES	NWK	32	7.250s	May 2014	35	73
K-V PHARMACEUTICAL	KV-A	68	12s	March 2015	60	35
K-V PHARMACEUTICAL	KV-A	68	2.5s	May 2033	18	16
ATP OIL & GAS CORP	ATPG	378	11.875s	May 2015	75	24
JAMES RIVER COAL CO	JRCC	148	4.5s	Dec 2015	50	27
JAMES RIVER COAL CO	JRCC	148	3.125s	Mar 2018	36.5	23

Pretty similar to the last list. Leaving GMXR and AONE off because we are already talking about those.

SA: "Opportunity In Low Natural Gas Prices With Bonds"

"This Chicken Little attitude in the bond market is unnerving, but it creates excellent short-term buying opportunities. Right now there are numerous gas company bonds at good discounts that are paying huge returns on very short maturities."

Cheap Debt, Upcoming Maturities, and Big Market Caps

Ticker	Company	Maturity	Bond Price	Market Cap	Optionable
GMXR	GMX Resources	Feb 13	65	100	Y
MNKD	MannKind	Dec 13	56	285	Y
THQI	THQ	Aug 14	50	42	Y
USU	USEC	Oct 14	47	147	Y
KV-A	K-V Pharma	Mar 15	67	80	Y
YRCW	YRC Worldwide	Mar 15	36	60	Y
GMXR	GMX Resources	May 15	49	100	Y
ATPG	ATP Oil & Gas	May 15	75	400	Y
JRCC	James River Coal	Dec 15	62	200	Y
HMIN	Home Inns & Hot	Dec 15	77	1200	Y
DNDN	Dendreon	Jan 16	78	1500	Y
AONE	A123 Systems	Apr 16	41	250	Y

CPI-Linked Bonds Are For Chumps?

This post is about Argentinian inflation numbers, not U.S. ones, which are relatively accurate. The bogus numbers here are the employment numbers.

The Economist has a long article this week about the Argentine book-cooking of inflation numbers, which are really 2-3x higher than official reports. In fact, the Economist will being disregarding the official numbers in favor of privately estimated ones.

When governments lie about inflation, it is a huge problem if you own CPI-linked bonds.

Proposition for audience: CPI-linked bonds are for chumps.

Think about it; you are letting the debtor choose his own interest rate. What is he going to pick? Duh, a low one.

The incentives are clear - don't be a chump.

Is High Yield Cheap?

"[T]here is a nominal yield for high yield bonds which reflects the risk. It doesn’t matter where Treasury yields are, high yield bonds don’t care. As a result, when people in the media, or writing blogs those argue that high yield is cheap because yield spreads are wide, it is time to disregard then when Treasury yields are artificially low"