It Toggles the Mind

Bloomberg is reporting Toggle Bonds Lose Taint as Subprime Contagion Falls

The worst part of the junk bond market is suddenly back in favor.

Companies raised about $4.4 billion in the past six weeks selling toggle bonds, securities that allow borrowers to pay interest in cash or with more debt, data compiled by Bloomberg show. Demand dried up in July and prices fell as much as 16 cents on the dollar as defaults on subprime mortgages contaminated global credit markets, according to data compiled by Bloomberg.

"When you have a lot of toggles, you know that the market's not too worried about risk," said Margaret Patel, who oversees $1.6 billion as a senior portfolio manager at Evergreen Investment Management Co. in Boston. They are "a bull market security," she said.

My comment: Bull market securities or bull market insanity? Typically the market is not worried about risk at the least opportune time. Indeed it is a necessary ingredient of a top.

The normal idea behind investing in bonds bonds is receiving a stream of interest payments commensurate with risk. Toggle bonds allow the payments to be more bonds. This is just another example of a financial perpetual motion device.

The music stopped on Chuck Prince and the music is going to stop sooner rather than later for this type of nonsense as well.

"To us, it's about, are you getting paid adequately?" said Paul Scanlon, managing director for high-yield at Boston-based Putnam Investments, which oversees about $65 billion in fixed- income. Putnam owns toggles sold by Dallas-based retailer Neiman Marcus Group Inc., according to Bloomberg data. Putnam has been buying more toggle bonds, Scanlon said, without specifying them.

My comment: Yes it is about "getting paid adequately". And to risk getting paid back in bonds rather than interest payments at a time of stress for a measly 1% or so extra, is not "getting paid adequately".

The securities issued since September were rated at least six levels below investment grade by Moody's Investors Service and Standard & Poor's. Debt ranked below BBB- by S&P and Baa3 by Moody's is considered high-yield, high-risk, or junk.

My comment: that fact that a significant market for BBB- toggles exists at all (especially in light of a credit crunch in other debt), shows just how much overconfidence there is in corporate junk bonds. Such overconfidence is historically been treated very badly. This time will be no different.

LBO firms are willing to pay the higher coupon on toggles because they give more flexibility in times of financial trouble.

"Within a short period of time it became the standard LBO financing," said Martin Fridson, head of high-yield research firm FridsonVision LLC in New York.

The five biggest LBOs this year involving bond sales used or planned to use toggles, including the TXU and First Data Corp. deals, according to Bloomberg data. Kohlberg Kravis Roberts & Co. bought Greenwood Village, Colorado-based First Data, the largest processor of electronic payments, for $26 billion in September.

The yields on the bonds made them irresistible for investors at a time when defaults by U.S. companies rated below investment grade fell to 1.13 percent in September, the lowest in a quarter century, according to S&P.

"It didn't matter what the credit was, they all wanted toggle bonds," said Mark Hudoff, a money manager at Newport Beach, California-based Pacific Investment Management Co.

My Comment: That last sentence says it all. It reminds me of the fools standing in line summer of 2005 hoping to be one of the lucky ones to be able to buy a Florida condo. Is anyone asking who will be left to buy in times of stress if "they all want toggle bonds" now?

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com
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