Sunday, January 11, 2009
Moments ago, I got the following update from the capital markets group at a huge financial institution. The short version is that the secondary market is continuing its pre-Christmas awakening, a necessary prerequisite for new lending:
There are a few items to note this week. Secondary trading levels were broadly positive, continuing the improvements in pricing we saw during the holiday season, but it is the continued improvement in technical factors that are most encouraging.
1) The primary measure of counterparty risk (TED Spread = 3 mo LIBOR - 3 Mo T Bill) declined again as 3 month LIBOR continued its retracement. This level, which had reached a wide of 464bps in October, now stands at 120bps. While this is still very wide to its pre-credit crunch range of between 20bps and 70bps, it is the average of the pre-Lehman Brothers failure Credit crunch level. So, at least with respect to this one measure of counterparty risk, the lending markets are back to their average credit crunch level pre-Lehman Brothers failure.
2) On Thursday, Cablevision priced the first High Yield bond of 2009. This is on the heels of the two very successful offerings Morgan Stanley conducted on behalf of El Paso Corp and Kansas City Southern during December. While this continues the trend of >10pt discounts and all-in >10% yields to investors, it signals that investors do have remarkably large cash balances and an appetite for attractively priced issuances from strong credits.
3) The final point we would like to note is a continuation of #2 - cash balances. An unscientific poll of investors that we conducted in December showed investors holding between 5% - 40% cash balances. Now some of this was conservative posturing because of expected cash withdrawals, but at least so far this year the exact opposite has occurred. AMG reported that High Yield mutual funds received a net $988MM inflow during the week ended Jan. 7, which is the 6th consecutive inflow (for a total of $2.8BN)and is the largest one week inflow since September 2003. Furthermore, Verizon's purchase of Alltel closed on Friday, resulting in the latter's repayment of its $14BN term Loan. So, if this continues, investors have no choice to but to put this cash to work. With yields and spreads at all time wides, no money manager can be caught with large cash balances as the technical factors continue to improve and High Yield trades more in line with fundamentals.
As previously reported (including in this exciting episode of TigerHawk TV), banks have not been making new loans because they can buy old loans at a discount and thereby earn a higher rate of interest than would be paid by any new borrower that was not desperate. These discounted loans are available because so many non-bank lenders have had to liquidate their positions to meet redemptions, their own obligations, and so forth. Somebody has to buy up all the old performing loans that have been on sale since the summer, and prices have to rise (thereby lowering the rate of return) before it will be equally worthwhile for banks to make new loans. Therefore, improved pricing in the secondary market is a necessary prerequisite to new primary lending. The secondary market has now strengthened for more than a month, so we may actually see a reopening of the new lending and original issuance high yield bond market before long. Keep your fingers crossed, and if you want to help things along put some money in a high yield bond fund!
Well, I was not forecasting an economic recovery, so much as an unfreezing of the credit markets, which some would say is a prerequisite to stopping the job losses, which is in turn a prerequisite to a recovery in consumer spending. But you can certainly look at it in other ways.
When capital markets are healthy enough to see trading liquidity at work in debt secondary markets and also strong enough to allow for equity raising as well as new debt origination, then I'll be more confident. If companies as financially healthy as Emdeon can't get an IPO done, as they have not yet been able to do, then it's not yet a recovering market. While we haven't seen recovery yet, it sure is good to read TH's "there might be glimmers of hope" posts.