High Yield

The great risk transfer into Other People's Money continues as evidenced by an absolute record amount of high yield issuance in March: so far was have seen $29.7 billion in bonds price and with over ten more deals announced for this week to take advantage of the euphoria gripping the three stocks (C, BofA, QQQQ) that now represent the entire stock market, we are sure to surpass $32 billion. Banks are scrambling to underwrite as many bonds as the buyside will accept knowing full well the new issue window will likely close soon (or at such time as the American middle class says enough to the great wealth transfer experiment conducted by the Federal Reserve). The last time we saw such irrational exuberance in bonds was in the months and days leading to the onset of the second great depression (oh yes, consumer confidence at 52.5, which about 30 below levels indicative of a healthy economy, came in better than expected).

If you were one of the unlucky few caught exposing Barclays' shenanigans over the past year while acquiring Lehman at subfiresale prices (and being sued for that now), you probably were not invited to the annual Lehman Brothers (yes, that's how it will always be know, and always with Brad Rogoff leading the charge) HY conference, this year held at the Phoenician in Scottsdale, AZ. On the other hand, even if you were invited, but like quite a few people, spent all your time in Jenna Jameson's Babe's Cabaret, and need to send your boss a summary of all you"learned" you must be about as pleased as Tim Geithner at a Tax Cheats Anonymous meeting. Fear not - here is the full presentation deck, chock full of cool stuff stuff, pretty graphs and bullish, bullisher, bullishest ideas. So buy all the worst junk before the market crashes again and Lehman still has gobs of crap paper on their books. Cause this time the Repo 105 reacharound just ain't gonna cut it.

$40 billion 3 Year closed at 1.437% high yield, 15.66% allotted at high; 1.403% median; 1.34% low

WI last traded at 1.447% at 1pm

Bid To Cover 3.13; previous 2.83, average 2.98

Primary Dealers bid 67.28% of total competitive bids of $124.9 billion

Indirect take down: 51.84% versus 53.53% average

Indirect hit ratio: 75.67%

Lipper FMI has reported that bank loan mutual funds saw $179 million in inflows, while HY funds increased their capital by $314 million in the week ended March 3. This compares to inflows of $228 million and $470 million in the prior week, and HY outflows of $1 billion for two weeks running in the weeks prior to this. If HY bond and loan mutual fund flows track the market, one would have expected a more spirited appearance from HY investors this past week.

• Yields 0.895% vs. Exp. 0.88-0.90
• Bid To Cover 3.33 vs. Avg. 3.21 (Prev. 3.13)
• Indirects 53.60% vs. Avg. 42.45% (Prev. 43.22%)
• Indirect hit ratio 65%
• Allotted at high 14.79%
• Direct take down: 8.2%

And just what HY investors did not want to hear after the Fed shocker: Lipper FMI just reported that High Yield bond funds saw $915.77 million in outflows for the week ended February 17, while bank loan mutual funds saw $160.9 million in inflows. Keep in mind last week was one of the largest outflows in HY in recent history at just under $1 billion. The high beta dumpage is officially on.

Even as AMG data was strangely missing late last night according to Prospect News' High Yield Daily, EPFR Global of Cambridge, Massachusetts, which uses a different methodology from AMG (i.e. a working one), indicated a major $1 billion outflow in high yield bond funds. This follows a $335 million inflow and a $137 million outflow in the past two weeks. Subsequently, Dow Jones confirmed the EPFR data, indicating that Lipper FMI recorded $984 million of outflows for the week ending Wednesday. As HY fund flow data is critical when pitching refi deals to junk companies, this key inflection point will likely stall not only the HY new issuance market, but will lead to substantial drops in secondary market prices for junk bonds.

• Yields 1.377% vs. Exp. 1.36%
• Bid To Cover 2.83 vs. Avg. 3.01 (Prev. 2.98)
• Indirects 51.2% vs. Avg. 54.12% (Prev. 38.09%)
• Indirect Bid To Cover lower at 1.16
• Allotted at high 26.75%
• Direct take down 10.07%
• Indirect take down 51.18%

Low policy rates don’t impact speculative grade debt so much. Mortality rates for lower-rated debt are much higher than investment-grade debt; the three year mark is where defaults really start to bite. Three years ago (2007), 51% of HY issuance was rated B or below. Mortalities have been accelerated by economic factors, but cumulative default rates will still be high. A buy-and-hold strategy with a broad index of HY debt consistently outperforms the Treasury benchmark. Trading strategies benefit from treasury positioning.

• Yields 1.490% vs. Exp. 1.513%
• Bid To Cover 2.98 vs. Avg. 2.99 (Prev. 2.98)
• Indirects 38% vs. Avg. 59.02% (Prev. 60.9%)
• Indirect Bid To Cover at 1.37
  
• Alloted at high 79.20%
• Direct bid surges from 2.9% in December to 23%

Indirect bid plunges to 38%, from 60.9% in December, 68.5% in November and a 59.02% average. Direct Bidders jump to a record 23% compared to 2.9% in December. This is a very material development in change of the traditional purchasers of govvies.

If the recent $750 million Clear Channel deal was not indication enough that the high yield market is now back to 2007 market top levels, the sudden resurgence of dividend recap deals should be a sufficient and necessary condition that company boards are now willing to throw any debt leverage caution to the wind and extract as much proceeds as possible during the current HY offering megaspree before the window closes with a bang. And with investors no longer even demanding any negative covenants, the rush to relever and cash out existing equity-holders will definitely end in tears. Of course, the Fed is there to backstop each and every balance sheet. If Goldman is too big to fail, bond investors will claims, so is 10x leveraged port-a-potty maker UnitedSiteServices (or so PE sponsor DLJ Merchant Banking would hope). And if there is one entity that is ecstatic with the current HY mania (in addition, of course, to equity sponsors who a year ago were staring bankruptcy in the face and are now extracting hundreds of millions on the back of gullible and potentially semi-retarded "long-onlies"), it is Wall Street banks, which have perfected the art of finding retarded idiot investors (in exchange for a meager 3% fee) who are happy to ignore the whited-out "Use Of Proceeds - dividend payment to existing equity" and throw their LPs' money down said port-a-potty.

• Yields 1.223% vs. Exp. 1.229%
• Bid-To-Cover 2.98 vs. Avg. 2.92 (Prev. 2.62)
• Indirect Bid-to-Cover 1.32
• Indirects 60.9% vs. Avg. 57.70% (Prev. 54.15%)
• Alloted high 50.40%

The base case number one takes the view that high yield default rates are peaking and will start to drop from this level now. The rate of unemployment ranges from 10% to 11.5% with this given scenario. In the base case number two, I am using a composite of both peaks in 1991 and 2002 to suggest that default rates may carry upward one percent more. The resulting effect on unemployment targets will range from 11% to 13.5%. In our final analysis base case number three will use the peak at 13% in default rates established in 1991. Unemployment rates in this scenario show a range of 12.5% and 15% before possibly peaking.

Not a good day for PIMCO as Calpers continues scapegoating for its deplorable performance, and today the California Pension manager decided to trim its exposure to PIMCO. In doing so, Calpers slammed the Newport Beach firm for being too risk averse (watch out Bill, you know what happened to John Mack for being too timid): "While PIMCO managed to return 35.06% [from January to September 2009], PIMCO's aversion to risk resulted in underperforming the benchmark return of 47.45% by 1,238 bp." The result: Calpers is pulling $100 million from PIMCO, however it is not firing the manager altogether and instead will consider "allocating more assets to PIMCO in the future when risk aversion is expected to produce alpha in the high yield market."

• Yields 3.47% vs. Exp. 3.475%
• Bid-To-Cover 2.81 vs. Avg. 2.83 (Prev. 3.01)
• Indirects 47.3% vs. Avg 40.78% (Prev. 47.24%)
• Indirect Bid-To-Cover 1.51
• Alloted high 82.49%
• Directs at 4.5% of Total accepted