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Wednesday, January 14, 2009 1:25 PM

Are Junk Bonds A Buy?

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In what I expect to be a wave of big name corporate bankruptcies, Canadian telecom giant Nortel files for bankruptcy protection.

Nortel (NT) said it filed for Chapter 11 bankruptcy protection in the U.S. and plans to make similar filings in Toronto and Europe. Operations in other parts of the world would not be affected.

In recent months, the telecommunications-equipment company's sales have fallen sharply, especially in North America. The company's stock, which once topped $860 a share adjusted for a 2006 reverse stock split, recently tumbled to as little as 21 cents. The New York Stock Exchange halted trading in the stock Wednesday at 32 cents a share.
Corporate Defaults Fastest Pace In Five Years

Companies are defaulting at the fastest pace in almost five years but but some think record high yields more than compensate.

Please consider Junk Debt Showing Great Depression Defaults Lures Investors.
Record yields on high-risk, high- yield bonds and loans are luring Babson Capital Management LLC and TCW Asset Management Co., even as companies default at the fastest pace in almost five years.

Investors poured $1.7 billion into funds that buy mostly non-investment grade bonds in the last five weeks of 2008, after pulling $10.5 billion in the year up until then, according to the mutual-fund tracking service EPFR Global in Cambridge, Massachusetts. The renewed appetite for the debt follows declines that pushed the junk-bond market down 26 percent last year.

Annual yields of 18 percent may compensate for the growing risk of corporate failures as the global economy slips into its worst recession since World War II, says Jill Fields, a managing director at Babson, which oversees $2.5 billion in high-yield bonds. 2008’s slump pushed yields so far they predict corporate defaults may surpass the rate of about 16 percent reached in 1933, the height of the Great Depression.

“There’s extraordinary value at today’s prices,” said Michael Zupon, who oversees Washington-based Carlyle Group’s leveraged-finance investments from New York. “The market is priced to anticipate around 20 percent annualized defaults. Even the most conservative prognosticators don’t expect that level.” Zupon said he favors loans to non-investment grade companies because loans get repaid first.

“In high-yield and loans, it’s priced for Armageddon,” said Jonathan Insull, a New York-based managing director at TCW. The Los Angeles-based firm holds $4 billion in bank loans.

At today’s prices, leveraged loans would return 5 percent even if 13 percent of companies default on their debt, according to LCD.

“We’re going to see defaults rise significantly, but this is largely priced in,” said Todd Youngberg, a senior vice president of high-yield debt at Aviva Investors in Chicago.

“14 to 16 percent is pretty good for companies I’m pretty sure are going to survive,” Fields said in an interview from her office in Springfield, Massachusetts.

Cerberus, the $27 billion investment firm that owns Chrysler LLC, thought trading levels for debt “were ridiculously low and there was a great buying opportunity,” Chief Executive Officer Stephen Feinberg wrote to investors in a letter Dec. 19. “We were wrong.”

High-yield bond funds have lost 21.5 percent on average in the last year, and loan funds are down 26.3 percent, according to Morningstar Inc. data. Long government-bond funds are the best-performing category, jumping 18.9 percent.
Clearly there is more than an ample supply of bottom callers on junk. Perhaps if one is looking at individual companies on a very selective basis there are some bargains, but color me skeptical on this love affair with junk as a general thesis.

Yields are what they are for a reason. And unlike 2002 when Greenspan fueled a credit bubble rescuing corporations that should have gone under, there will be no such miracle this go around.

Mike "Mish" Shedlock
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