Unlocking the High Yield Bond Market Martin Fridson CEO - - PowerPoint PPT Presentation

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?

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Yield-To-Worst: High Yield Master II Index

and Five-Year Treasury Index Monthly, December 1996 – January 2013

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Exhibit 1

Source: BofA Merrill Lynch Global Research, Used with Permission

5 10 15 20 25 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 Percent High Yield Universe Five Year Treasuries

Option-Adjusted Spread: High Yield Master II Index

Monthly, December 1996 – January 2013

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Exhibit 2

Source: BofA Merrill Lynch Global Research, Used with Permission

500 1000 1500 2000 2500 Basis Points OAS Mean OAS (601)

Global Default Rate

Percentage-of-Issuers Basis Annually, 1981 – 2012

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Exhibit 3

2 4 6 8 10 12 Percent

Source: Standard & Poor's

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New Issuance vs Net Increase in Outstanding

U.S. High Yield Bonds, 1999-20121

Exhibit 4

• 50

50 100 150 200 250 300 350 400

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

$Billion Sources: BofA Merrill Lynch Global Research, Bloomberg New Issuance Net Increase

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Actual Spread minus Fair Value

Monthly, December 1996- January 20133

Sources: BofA Merrill Lynch Global Research, Bloomberg, S&P, Federal Reserve

Exhibit 5

• 400
• 300
• 200
• 100

100 200 300 400 500 600 12/31/1996 5/31/1997 10/31/1997 3/31/1998 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 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 Basis Points + 1 Standard Deviation

• 1 Standard

Deviation

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

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Has New Issue Boom Trashed Credit Quality?

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Triple-C as Percent of High Yield Universe

By Face Amount, 1996 - 20122

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Source: BofA Merrill Lynch Global Research, Used with Permission

5 10 15 20 25 30 35 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Percent

Exhibit 6

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

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Is LBO Volume about to Surge?

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High Yield Spread versus LBO Volume

U.S., Annually 2001-2012

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Sources: BofA Merrill Lynch Global Research, Used with Permission, Bloomberg

Exhibit 7

y = 577.23e-0.003x R² = 0.5311 100 200 300 400 500 600 700 200 400 600 800 1000 1200 1400 Basis Points

Option-adjusted spread, weekly average (bps)

Conclusion:

• Modest rise in LBO volume likely in

2013

• Credit implications moderately

unfavorable

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For the Past Century Beginning Yield Has Controlled Annualized Return over Next Four Years

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Quadrennial Promised and Realized Yields on Low-Rated Bonds

1912-1943

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Exhibit 8

y = 2.1367x - 13.655 R² = 0.6011

• 10
• 5

5 10 15 20 25 2 4 6 8 10 12 14 16 18 Promised Yield (%) Realized Yield (%)

Source: W. Braddock Hickman, Corporate Bond Quality and Investor Experience (Princeton University Press, 1958)

Trailing-Four-Year Periods Beginning 1981-2009 Yield-to-Maturity and Annualized Return

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Exhibit 9

y = 1.5925x - 9.352 R² = 0.6875

• 5

5 10 15 20 25 5 10 15 20 25 Beginning Yield-to-Maturity (%)

Annualized Four-Year Return (%)

Note: High Yield 100 (1981-1984), Master (1985-1987), Master II (1988-2009) Source: BofA Merrill Lynch Global Research, used with permission

Conclusion

• Expected return for 2013-2016 is

1.40% annualized

• Something exceptional must occur for

high yield to earn the coupon over that period

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Contact Information

Martin Fridson CEO FridsonVision LLC 1-917-403-9194 marty@fridson.com