Yield crazy
The bond market is still red hot, pretty much in all sectors and practically around the world. The French government just sold a 50-year bond to yield 4.21%. The deal was so hot it had to be upsized to 6bn Euros ($7.9bn). For those of us who remember the 15% treasury (with inflation running well into double digits), it seems a bit weird. Why would anyone go for a deal like that?
Meanwhile another record was broken in the securitized market, where homebuilder Centex sold a $1bn deal at 7bps over 1-month LIBOR for the top tier (1-yr paper). The 3-yr tranche was at 17bps. In other words, the market is looking at them as being just about as safe as treasuries. Asset-backed securitization deals in 2004 amounted to a record level of almost $900bn (vs $585bn in 2003), and so far this year is ahead of last. The assets in "asset-backed" are mostly houses, cars and other unspecified loans. (Some of them were a little more unusual -- like, for example, the David Bowie, James Brown and Isley Brothers music-royalty deals -- shades of Hollywood Stock Exchange here).
What are securitized loans? OK, say you want to buy $100mm of mortgages yielding $6mm a year in interest. You issue $90mm of 1-year "asset backed" paper yielding LIBOR + 20 or 3.1% right now. The rate is nice and low because the paper is "overcollateralized" ($100mm of assets covering $90mm of paper) and there's a lot of buyers. Then you put in $10mm of your own cash to fund the rest. So you pay out roughly $2.8mm in interest to the asset-backed guys and get to keep the $3.2mm balance. So you're earning 32% on your $10mm of equity. Pretty nice, ey?
But what happens, I hear you asking, when you have to refinance the 1-year paper, short-term rates have shot up and house prices have collapsed? Yeah, well, that's leverage for you, gotta take the rough with the smooth.
It's the same story all over the fixed income market. Spreads are way down in emerging market (3rd world) debt and in junk corporates (which had a record year for issuance, at $140bn, last year and is still pretty hot, even though, according to the rating agencies, the proportion of "triple-hook" (CCC) debt has been steadily rising). Everyone's looking for yield.
What's driving all this? Our friend the Span, of course, and his liquidity-crazed cronies at other central banks around the world. They've been pumping money into the system with what you might call "irrational exuberance". If you can get money so cheap, why wouldn't you go out looking to play the spread (between what the money costs you and what you can lend it out at)? No wonder there's a new hedge fund every two minutes.
Meanwhile another record was broken in the securitized market, where homebuilder Centex sold a $1bn deal at 7bps over 1-month LIBOR for the top tier (1-yr paper). The 3-yr tranche was at 17bps. In other words, the market is looking at them as being just about as safe as treasuries. Asset-backed securitization deals in 2004 amounted to a record level of almost $900bn (vs $585bn in 2003), and so far this year is ahead of last. The assets in "asset-backed" are mostly houses, cars and other unspecified loans. (Some of them were a little more unusual -- like, for example, the David Bowie, James Brown and Isley Brothers music-royalty deals -- shades of Hollywood Stock Exchange here).
What are securitized loans? OK, say you want to buy $100mm of mortgages yielding $6mm a year in interest. You issue $90mm of 1-year "asset backed" paper yielding LIBOR + 20 or 3.1% right now. The rate is nice and low because the paper is "overcollateralized" ($100mm of assets covering $90mm of paper) and there's a lot of buyers. Then you put in $10mm of your own cash to fund the rest. So you pay out roughly $2.8mm in interest to the asset-backed guys and get to keep the $3.2mm balance. So you're earning 32% on your $10mm of equity. Pretty nice, ey?
But what happens, I hear you asking, when you have to refinance the 1-year paper, short-term rates have shot up and house prices have collapsed? Yeah, well, that's leverage for you, gotta take the rough with the smooth.
It's the same story all over the fixed income market. Spreads are way down in emerging market (3rd world) debt and in junk corporates (which had a record year for issuance, at $140bn, last year and is still pretty hot, even though, according to the rating agencies, the proportion of "triple-hook" (CCC) debt has been steadily rising). Everyone's looking for yield.
What's driving all this? Our friend the Span, of course, and his liquidity-crazed cronies at other central banks around the world. They've been pumping money into the system with what you might call "irrational exuberance". If you can get money so cheap, why wouldn't you go out looking to play the spread (between what the money costs you and what you can lend it out at)? No wonder there's a new hedge fund every two minutes.
posted by econoclast at 2:03 PM
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