Thursday, December 18, 2008

Corporate Bonds: Discounting Depression...

Update below.
From Dead Cats Bouncing:
With the TIPS market discounting maybe 5 years of deflation, and government bonds generally oblivious to the ultimate success of heroic reflation efforts, the corporate bond market remains in deep freeze. Spreads on Baa credits at an unprecedented 640 bp, or 3.5 times the average spread prevailing over the past four decades, and the highest levels since the 1930's (when US GDP fell 25% peak to trough). Their previous record peak was in the depths of the early 1980's recession at well under 500bp. To put this in perspective, the peak default rate on investment grade bonds during the Depression was 4%, and 21% for all credits; we're currently discounting almost a 30% default rate. That just isn't going to happen, and the current valuation extreme has been driven largely by forced deleveraging by financial institutions and chaos in the CDS market. As retail investors seek income in a global ZIRP environment and financial markets stabilise, I suspect we will see a sharp rally in 2009....MORE
I like this bit:
...Bank bonds look particularly mis-priced, yielding 5% over comparable Treasuries when blue chip US bank bonds are de facto the new Agency Debt, and indeed bank debt in all developed economies now carries an implicit government guarantee....
Update-from Bloomberg:
Morgan Stanley Bought Back Its Own Debt to Avoid `Bad Signal'
Morgan Stanley repurchased $12.3 billion of its own bonds in the past three months ``at incredibly distressed levels'' to try to limit the declines as investors became concerned about the company's credit quality.

``We were buying debt as part of a debt defense,'' Chief Financial Officer Colm Kelleher told analysts during a conference call today. ``If I had let it sit out there, it would have sent a very bad signal.''

Morgan Stanley bonds tumbled after the Sept. 15 bankruptcy of smaller rival Lehman Brothers Holdings Inc., with 6.625% senior unsecured notes that mature in April 2018 dropping as low as 61 cents on the dollar on Oct. 10. They were trading at 86.5 cents on the dollar today...MORE

Although Morgan had a motivation different from that assumed in the DCB story, the point is the same: corporates are discounting "not just the end of the world but the hereafter as well".

(I put that line in quotation marks because I'm not sharp enough to have thought it up but I have no idea who first used it)