Tags: Risky | Bonds | Crisis | Return

Risky Bonds That Sparked Crisis Return to Credit Markets

Tuesday, 20 Apr 2010 08:55 AM

By Dan Weil

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Some of the high-risk bonds that helped fuel the financial crisis are back in the credit markets, as investors search for higher returns.

For example, companies are issuing pay-in-kind bonds. The interest payments for those bonds are made not in cash, but in more bonds. In addition, companies are issuing bonds to offer large dividends to their owners.

Investors also have resumed buying mortgage bonds that aren’t guaranteed by the government.

"We've been through a period where nothing really ambitious got done," Steven Miller, head of Standard & Poor's Leveraged Commentary and Data group, told The Wall Street Journal.

"Now we're entering a recovery-phase period, similar to 2004-05 or 1995-96, where we're starting to see people push at the edge of the envelope."

For example, privately-held companies issued $8.8 billion worth of bonds in the first quarter to pay dividends to their owners, more than all of last year, according to S&P.

Obviously this return to risk presents danger for financial markets. It was excessive risk-taking in various fixed-income securities that sparked the financial system’s near meltdown in 2008-09.

Ned Zachar, a portfolio manager at KLS Diversified Asset Management, says investors are more disciplined now.

But, "If we see multiple (pay-in-kind) deals as a means to defer debt service, I think that would be an unfortunate mid-2000s flashback."

Analyst Walter Zimmermann of United-ICAP is certainly worried.

"We look at this as a replay of what happened in 2007," he told MarketWatch.

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