Market Timing on Debt

The historical “rule of thumb” is that markets are rational. This is likely true over some period of time, but not in the short run.

A recent article in the WSJ (more like a blurb, on the back page) called “The Big Number” described the current situation with junk bonds.

Yield hungry investors are making the bond market a welcoming place for even the lowest rated borrowers. The average yield paid by new triple-C rated issuers (i.e. “junk”) of corporate bonds in the third quarter hit a record low.

The current yield on new CCC bonds is 9.05%, down from 10.65% in the second quarter of last year. This is a decline of 18% in about a year, which is a giant decrease for a company considering re-financing.

In addition to being able to sell debt at the lowest rates in years, these highly leveraged firms are also able to find buyers for their debt (i.e. the market is liquid).

When the market freezes up, as it did in 2008, there are two main impacts – 1) the rates that everyone pays for financing in the short term move up sharply 2) there is little financing available for those that don’t have the strongest credit. In practical terms, #2 means that if you need money, it will cost you very dearly such as when Goldman Sachs had to borrow from Warren Buffet at a 10% preferred stock issuance.

While it is very difficult to determine the right time to buy and sell, there is no doubt that “market timing” is of incredible importance. If you have a highly leveraged company, these low rates and many yield hungry buyers willing to lend to you means that you can retire very high cost debt, load up on lower cost debt, and roll out maturities for many years, buying your company valuable time in case there is a recession or business downturn.

Today is literally the opposite point of time in terms of market timing from when Goldman Sachs was forced to pay 10% rates to Buffett; today even the lousiest company (in terms of credit ratings) can get funding cheaper than that (9.05%, per this article). This doesn’t mean that rates won’t still fall – if I could predict that I’d be on an island somewhere – but it does show the amazing difference in market conditions that just a few years made, without the economy itself changing in any substantive manner.

Who is buying all of this? Right now your bank account and CD’s effectively pay almost zero, and US government debt 10 years out is 1.6%. Thus for someone who wants income, an investment that pays 9.05% LOOKS a lot better than under 2%.

The flip side of loaning to the most highly leveraged, lowest rated companies, is risk. Risk can be business risk or their continued ability to find low rate financing (liquidity).

On a market timing basis, this is the best time for these sorts of companies.

Cross posted at Chicago Boyz

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