High Yield Credit Spreads Out of Control

by: Bespoke Investment Group December 04, 2008    

Bespoke Investment Group

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If you're a company with less than perfect credit looking to borrow money, hopefully you have made other plans. As shown below, based on data from Merrill Lynch, high yield spreads keep rising and have shown no signs of letting up. As of Wednesday's close, the spread between high yield debt and comparable Treasuries is 2,039 basis points. As shown in the chart below, spreads are well into record territory and the rate of increase has turned parabolic. Additionally, since bottoming in June 2007, high yield spreads have increased by nearly 750%.

With the 10-Year Treasury currently yielding about 2.65%, high-yield borrowers currently have to pay nearly 23% per year to borrow money for a ten-year period. It's going to take pretty high margins to maintain profitability in this kind of environment.

High Yield Spreads 120408

High Yield Spreads 120408a

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This article has 3 comments:

  •  
    Dec 04 05:40 PM
    Hey Guys, love your stuff. Just thought an FYI was needed on this one. Corporate bond land is incredibly illiquid currently (especially HY) with very little actual trading going on. Primary issuance is up a little this month (though not in HY) but concessions remains extreme. What this means is that using corporate bond spreads to judge HY default compensation is a little tricky. As an example, in general, bonds are trading over 200bps wider than CDS on the same name due to counterparty risk in CDS, funding costs for bonds (hedgies), risk aversion, and liquidity. This so-called basis is what has undone Citadel for instance and we note that in CDS land, HY11 seems to have found a cap at around 1400bps this week (as IG continues to widen). This is a CDS spread (similar to a spread over Libor) so you must adjust for the swap spread to compare apples to apples with your data BUT Merrill's bond indices may not be the best indication of just how stressed HY is. We are big bears on HY but if average spreads were indeed north of 2000bps then we would see significantly more people dipping their toes (but in fact liquidity is just not there to support this level). With CDS at 1400bps ish for HY, we remain sellers with a view that default gains will swamp carry costs as refinancing is basically impossible at current levels.

    A good indication of just how messed up this can be is the Muni market today (which now trades wide of the IG Corporate Bond market) - yes, you heard me - MCDX at 285, IG11 at 275!!! MCDX is 80bps wider today as state after state reports drastic drops in revenues...
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  •  
    Dec 04 07:34 PM
    Fatal, it's just fatal. It's like Volcker was back at the Fed. Except now we're printing like fevered dervishes.
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  •  
    Dec 04 08:40 PM
    anyone knows if muni default is picking up? less revenue comming in, and baloon muni expense. no supprise for muni default to pick up. but how bad?
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