C.M.O. 4.29.2009

Credit Market Overview
April 29, 2009

At this point in the economic cycle we are all pretty familiar with what a “Junk” bond is. Some have learned this lesson by watching what they thought was not junk turn into junk. Others have hopefully learned the information without having to experience the pain. Learning is the key here as the constantly changing dynamics of the market place give us opportunities to, as the saying goes: “learn something new everyday.”

For those watching the box scores the CDX Hi-Yield CDS index closed yesterday at 1223.6 in New York. This is the lowest level seen in that index since December 24th of 2008 and 701bps or 36.4% lower than the recent high of 1924.6 on March 9th of this year.

Back to junk and learning . . . so, junk bonds have been in the popular lexicon for at least a generation and in existence for much longer than that. Using the term junk, up to this point at least, was so ingrained in our market psyche that the word bond did not have to follow it. Just like Cola doesn’t have to follow Coke and copy doesn’t have to follow Xerox for you to get your point across.

The use of the word Coke is probably even more powerful as it immediately brings to mind a brown, carbonated beverage that can take the paint off of cars regardless of whether the label says Coca-Cola, Pepsi or Royal Crown.

It now seems, however, that the “junk” tree has grown another branch as the term is being used for stocks trading below $5.00 that once traded well above that more modest level. If you don’t believe me check out Monday’s WSJ.

In setting up the universe of stocks to monitor for the CEC Portfolio the original criteria were simple; an actively traded CDS market in the name and a stock price over $10. There were originally about 375 names that made it over the bar. That number rose to about 425 at the height of the market. I have kept any name that continues to have an actively traded CDS market regardless of price as these are probably the names I will be trading actively again if/once things turn around.

After reading the article I thought it would be interesting to see how many of the CEC names had fallen into the new category of “junk stocks”. As of this morning there are 101 names in the CEC Universe (names the CEC Strategy could possibly position.) that were trading under $10 and 63 trading at less than $5.

This second category includes such august names as FRE, FNM, AIG, GM, F, HOV and many others. Also in this category are names that, although not defunct, are trading below the $2.00 level. (Should probably clean those out but, hey, you gotta have hope!)

Let’s look at a couple of familiar names and see what the CDS/equity relationship is saying.

SLM – Recent high in the stock was $11.74 on 1/13/2009, low in the CDS occurred on 1/7/2009 at 659bps. The stock started to crater after Feb 2nd falling from $11.67 to $3.19 by March 6th. The CDS went ballistic during this time period rising from 701bps on 2/9/2009 to 2966bps on 3/9. Since the 9th the CDS has narrowed more than the stock has risen closing last night at 1532bps and $4.63. Uncertainty regarding how SLM will fit into a nationalized student loan program could well be hampering the stock while recent improvements in the credit markets have allayed fears of SLM going belly up, for now.

RRI – The CDS/equity combo here has made a few distinct moves since the beginning of the year with the CDS range bound in the 1000bps – 1100bps range until 2/20/2009 after which it soared to 1624pbs on 3/5 only to come back down to it’s recent range around 800bps. The stock moved first, back on 2/9, falling from $5.78 on that day to $2.23 on 3/9. It has since moved up to $5.03 before settling at $4.41 yesterday.

DDR – An interesting name given all the commercial real estate news flying around has seen 4 tradeable moves since November 4th of last year when the stock closed at $13.15. The CDS bottomed just two days later at 1248bps on 11/6. From these levels the stock went as low as $2.58 on 11/21/2008 and the CDS peaked on 11/28/2008 at 2861bps. After that the stock rose to $7.39 on Jan 8th of this year just after the CDS bottomed at 1961bps on 1/7. It was off to the races for the CDS after that putting in a double top at 2966bps on 2/23 and 3/12 of this year while the stock sank to $1.34 on March 9th. The CDS has come down to 1848bps as of last night and the stock has done a “three-bagger” closing at $3.69 last night.

Not everyone is comfortable trading stocks in the low single digits but it is comforting to know that the same CDS/equity relationship that works in Blue Chipville works equally as well on the other side of the tracks.

Enjoy the week.

Jim Delaney