High Yield Bonds:
The Growing Challenge
Martin Fridson, CFA
CEO, FridsonVision LLC
212-937-0975 [email protected]
www.FridsonVision.com
Fallacy of Composition
Source: Merrill Lynch & Co.
1987-2005
0 2 4 6 8 10 12 14High Yield Intermediate Treasuries Investment Grade Corporates
P
er
cen
t
Default Rate
Source: Moody’s Investors Service.
Moody’s Speculative Grade Default Rate, Trailing-Twelve-Months
U.S. Percentage of Issuers, Q1 1997 – Q1 2006, Quarterly
0% 2% 4% 6% 8% 10% 12% Q1 1997 Q2 1998 Q3 1999 Q4 2000 Q1 2002 Q2 2003 Q3 2004 Q4 2005
New Issuance Quality
Sources: Advantage Data, Bloomberg.
Percentage of New Issuance Rated BB- and Higher by Senior-Equivalent Rating
By Number of Issues, 1997-2005
0% 10% 20% 30% 40% 50% 60% 70% 1997 1998 1999 2000 2001 2002 2003 2004 2005Default Rate and Risk Premium
* Moody’s Speculative Grade Default Rate, Trailing-Twelve-Months, U.S. % of Issuers. ** U.S. High Yield Master II Index (H0A0) YTM minus U.S. Treasury, Current 10-Yr (GA10) YTM. Sources: Merrill Lynch & Co., Moody’s Investors Service.
Default Rate* versus High Yield Spread-versus-Treasuries**
Q3 1986 – Q1 2006, Quarterly
0% 2% 4% 6% 8% 10% 12% 14% Q3 1986 Q3 1989 Q3 1992 Q3 1995 Q3 1998 Q3 2001 Q3 2004 0 200 400 600 800 1,000 1,200Default Rate (Left Scale) Spread-versus-Treasuries (Right Scale)
High Yield Index Total Return
Source: Merrill Lynch & Co.
1987-2005
-10 0 10 20 30 40 50 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 Pe rc e n tHigh Yield Total Return and
Total Return Premium
Source: Merrill Lynch & Co.
Years between Trough and Peak Default Rate
-1,998
-5.12%
2000
1,076
2.51%
1999
-981
2.95%
1998
211
13.27%
1997
-1,124
-4.36%
1990
-1,441
2.31%
1989
Total Return Premium (basis points)
Total Return
Year
BB vs. B: Total Return Differential
Source: Merrill Lynch & Co.
1989-2005
-20 -15 -10 -5 0 5 10 15 1989 1991 1993 1995 1997 1999 2001 2003 2005 Pe rc en tDynamics of Industry Returns
Source: Merrill Lynch & Co.
Transition of Industry Rankings by Total Return
Semiannual Basis
6.14 2.71 3.64 6.36 Average 8 3 5 8 1H 2004 4 1 3 4 2H 2003 9 5 3 8 1H 2003 8 3 3 6 2H 2002 7 5 2 7 1H 2002 5 2 2 4 2H 2001 6 5 4 9 1H 2001 6 1 5 6 2H 2000 5 2 5 7 1H 2000 5 2 4 6 2H 1999 9 6 3 9 1H 1999 6 0 6 6 2H 1998 3 1 3 4 1H 1998 5 2 3 5 2H 1997 na na na na 1H 1997 New in Bottom 10 From Bottom 10 to Top 10From Middle to Top 10 New in Top 10
Period
Industry Returns
Note: Only industries with 10 or more issues are shown. Source: Lehman Brothers.
Industry Rankings by Total Return
Second Half of 2005
1.86% Natural Gas Pipelines
1.75% Aerospace/Defense 1.60% Consumer Products 1.08% Media Cable 0.90% Retailers 0.47% Packaging 0.24% Home Construction -0.31% Electric Utility -3.16% Paper -3.62% Automotive Bottom 10 3.70% Oil Field Services
3.72% Textile 3.84% Construction Machinery 4.06% Wireless 4.18% Other Industrial 5.04% Environmental 5.14% Transportation Services 5.29% Wirelines 5.54% Entertainment 5.70% Airlines Top 10 Total Return Industry
Industry Value Tracker
Note: Based on Spreads as of April 24, 2006.
Sources: Advantage Data, FridsonVision LLC, Lehman Brothers.
Cheap
Rich
14 7.14% Lodging 14 14.29% Wireless 19 15.79%Oil Field Services
59 16.95% Electric 17 17.65% Gaming 51 25.49% Pipelines 14 28.57% Industrial Other 17 29.41% Aerospace/Defense 14 42.86% Transportation Services 39 43.59% Technology 13 46.15% Media Cable 13 46.15% Consumer Products 15 46.67%
Food & Beverage
15 46.67% Environmental 15 53.33% Packaging 40 55.00% Retailers 25 56.00%
Consumer Cyclical Services
21 57.14% Chemicals 51 58.82% Health Care 12 66.67% Metals/Mining 28 67.86% Wirelines 45 71.11% Independent Energy 18 77.78% Automotive 27 81.48% Media Non-Cable 18 88.89% Paper Total # of Issues % Trading Wider than Estimated
Industry
Industry Value Tracker Performance
Sources: Advantage Data, FridsonVision LLC, Lehman Brothers.
Total Returns Relative to High Yield Index
August 20, 2003 to March 9, 2006, Monthly Basis
-0.02%
2,980
Total
-0.10%
589
Rich
-0.01%
2,150
Neutral
0.09%
241
Cheap
Average Outperformance
# of Cases
Category
Distressed Index Total Return
Source: Merrill Lynch & Co.
1997-2005
-5.02 -26.23 -6.59 -24.52 -17.42 -22.46 78.71 24.78 -15.95 -40 -20 0 20 40 60 80 100 1997 1998 1999 2000 2001 2002 2003 2004 2005 Pe rc e n tDistressed Debt Index Face Value
Source: Merrill Lynch & Co.
At Beginning of Year, $ Billion
0
25
50
75
100
125
150
175
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
New Issuance Volume
Source: Bloomberg.1999-2005
92.4
42.6
79.3
58.8
130.5
136.2
99.9
0
20
40
60
80
100
120
140
160
1999
2000
2001
2002
2003
2004
2005
$ B
illio
n
U.S. Debt versus Equity
Equity outperforming Debt
April 12, 2006 to April 19, 2006
Sources: Bloomberg, Lehman Brothers.
-16.90% 17.14% 0.24% EPL US 08/01/10 8.750 ENERGY PARTNERS LTD -17.74% 16.99% -0.75% FCX US 02/01/14 6.875 FREEPORT-MCMORAN C & G -19.06% 18.93% -0.13% BTU US 04/15/16 5.875
PEABODY ENERGY CORP
-19.25% 18.09% -1.16% GRP US 08/15/15 6.125
GRANT PRIDECO INC
-20.77% 20.77% 0.00% TEN US 11/15/14 8.625
TENNECO AUTOMOTIVE INC
-20.96% 21.45% 0.49% AMKR US 02/15/08 9.250
AMKOR TECHNOLOGIES INC
-21.75% 17.90% -3.85% CNST US 12/01/12 11.000 CONSTAR INTERNATIONAL -23.82% 23.32% -0.50% VMI US 05/01/14 6.875
VALMONT INDUSTRIES INC
-25.31% 25.31% 0.00% VC US 03/10/14 7.000 VISTEON CORP -26.25% 26.98% 0.73% NEU US 05/01/10 8.875 ETHYL CORPORATION Difference Stock Price Change Bond Price Change
Stock Ticker Maturity
Coupon (%) Issuer
U.S. Debt versus Equity
Debt outperforming Equity
April 12, 2006 to April 19, 2006
Sources: Bloomberg, Lehman Brothers.
6.29% -5.92% 0.37% HGR US 02/15/09 10.375
HANGER ORTHOPED GROUP
7.22% -10.00% -2.78% TBC CN 03/15/12 7.750
TEMBEC INDUSTRIES INC
7.69% -6.64% 1.05% CAO US 01/15/14 7.000 CSK AUTO INC 7.72% -7.48% 0.24% GLBC US 12/15/14 10.750
GLOBAL CROSSING UK FINANCE
8.18% -8.18% 0.00% AMD US 11/01/12 7.750
ADVANCED MICRO DEVICES INC
8.37% 0.86% 9.23% DRRA US 05/01/09 9.000 DURA OPERATING 10.56% -9.33% 1.23% DNK LN 06/15/10 11.000
DANKA BUSINESS SYSTEMS
10.96% -10.96% 0.00% MZ US 05/15/11 11.500
MILACRON ESCROW CORP
12.90% -12.90% 0.00% EMMS US 05/15/12 6.875 EMMIS OPERATING CO 23.68% -20.27% 3.40% WLV US 08/01/08 7.375 WOLVERINE TUBE Difference Stock Price Change Bond Price Change
Stock Ticker Maturity
Coupon (%) Issuer
U.S. Debt versus Equity Performance
Sources: Advantage Data, FridsonVision LLC, Lehman Brothers.
