As Credit Bubble Grows, Junk Bond Underwriting Fees Drop To Record Low

Back in February, Fed governor Jeremy Stein warned of overheating (read: bubble conditions) in credit markets. Nobody cared. A few months later, while observing among other things the ongoing credit bubble, none other than the central banks' central bank said the "central banks must head for the exit and stop trying to spur a global economic recovery" and that the "monetary kool-aid party is over." It wasn't, and naturally nobody cared either - as we would find out a few months later the party would go on as it turned out banks have no other choice but to keep the kool-aid flowing. Then over the weekend, just in case, the BIS tried once again, this time "sounding the alarm over record sales of PIK Junk Bonds" combining what it said previously together with Jeremy Stein's warnings (of course, nobody would care this time either).

Bloomberg summarized the BIS report (linked) as follows:

Record sales of high-yield payment-in-kind bonds are triggering uneasiness among international regulators concerned that investors may suffer losses when central banks tighten monetary policy.


Issuance of the notes, which give borrowers the option to repay interest with more debt, more than doubled this year to $16.5 billion from $6.5 billion in 2012, according to data compiled by Bloomberg. About 30 percent of issuers before the 2008 financial crisis have since defaulted, the Bank for International Settlements said in its quarterly review.


Companies are taking advantage of investor demand for riskier debt as central bank stimulus measures suppress interest rates and defaults approach historic lows. The average yield on junk-rated corporate bonds fell to a record 5.94 percent worldwide in May, Bank of America Merrill Lynch index data show, while global default rates dropped to 2.8 percent in October from 3.2 percent a year earlier, according to a Moody’s Investors Service report.


Low interest rates on benchmark bonds have driven investors to search for yield by extending credit on progressively looser terms to firms in the riskier part of the spectrum,” according to the report from the Basel-based BIS. “This can facilitate refinancing and keep troubled borrowers afloat. Its sustainability will no doubt be tested by the eventual normalisation of the monetary policy stance.”

Warning, shmarning: the truth is that as long as the Fed continues pushing everyone into the riskiest assets (so essentially forever), the demand for High Yield, aka Junk Bonds will rise. Although technically, "High Yield" is no longer the appropriate name for the riskiest credit issuance since the average coupon has declined to where Investment Grade used to trade in the years before the New Normal. It is therefore only appropriate that as part and parcel of this record high yield bond issuance surge levering the riskiest companies to the gills with low interest debt, that there is also a scramble between underwriters to become as competitive as possible. And, sure enough, as Bloomberg Brief reports, "the underwriting fees disclosed to Bloomberg on U.S. junk bond deals average 1.276 percent for the year to date, the lowest since our records began. The prior low was set in 2008, when fees averaged 1.4 percent." 2008... that was when the last credit bubble burst on unprecedented demand for junk bonds: we are confident the bubble apologists will find some other metric with which to convince everyone that reality, and the Fed's Stein, have it all wrong.

In the meantime, this is what a real bubble, if not so much in underwriting fees, looks like.

And by underwriter:


Finally, as a courtesy reminder what happened the last time the credit bubble hit such epic proportions, here again is the BIS:

The trend towards riskier credit was fairly general. It spurred, for example, the market for payment-in-kind notes. …This rise occurred despite evidence of the riskiness of payment-inkind notes: Roughly one third of their pre-crisis issuers defaulted between 2008 and mid-2013.


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