C.M.O. 5.21.2009

Credit Market Overview
May 21, 2009

The amount of new issuance in the both the equity and debt markets has been prodigious since the first drips appeared to be falling from the ice that had frozen the capital markets after Lehman took on Arnold “Da Gubenator” Schwarzenegger’s character in Batman, Mr. Freeze.

This has been heralded as a sign of that we are on the road to recovery and the move in credit spreads has been impressive with the oft cited difference between risk free Treasuries and a pile of junk (bonds) moving from the big 2-0 down to the lowest “teen” there is.

There is another side to all of this joyous issuance however and it comes in the form of a “what-if”. Don’t they always?

This w/i comes from the middle word in one half the two elements that are used in the CEC Strategy. Since one half is equity we can leave that one out and go directly to the other half Credit Default Swaps. I think you can pick the middle out of those three.

Moody’s expects the default rate on junk debt outstanding to hit a high of 16.4% by November of this year. Standard & Poors has a slightly different trajectory projected with defaults hitting their apex in March of 2010 at the 14.3% level.

Since we can’t believe much of what either of these two say these days a look at hard facts might help. S&P recently put out a report that said that no less than 28 entities had negotiated with their lenders to “extend payment, convert debt to equity, purchase debt back at a discount, reissue debt at more favorable terms” or D, all of the above.

Those numbers are through the end of April and if you add 2, because you have to figure that’s already happened in May or will by month’s end, you get a total of 30 which is twice the total for all of 2008. Without adding the extras the existing total is still quadruple the occurrences of 2007.

Keep in mind as well that $190BN of this less than investment grade debt is due to come up for refinancing over the next three years. If there is a glimmer of hope it is that the schedule of maturities is $26BN, $44BN, and $120BN for 2009, ’10 and ’11 respectively.

This should work out just about perfect because 2011 is when a good portion of the “timely, targeted and temporary” monies in the pork-ulous bill hits the streets.

If, by chance, defaults do rise over the next trio of years Dianne Vazza, a MD with S&P is not too optimistic about what actual recovery levels would be. “I don’t expect recoveries to be as strong this time around as in the past cycles, when recoveries were typically around 45 cents on the dollar. They’ll be hurt by the lousy economy, wounded banking sector, a lack of debtor-in-possession financing and the crummy leveraged deals done by the private-equity sector in 2006 and 2007. There will be more liquidation, in which recoveries typically suffer, this time around.”

Well . . . thank you Ms. Vazza, I did not realize that the new Batman movie was going to feature a Ms. Freeze in the upcoming sequel.

The forecast for NYC is a very sunny high of 85 degrees. Take that Mr. & Ms. Freeze!

One more wake-up and a half-day for the bond market tomorrow. Almost there.

Jim Delaney