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My Two Cents

The Kitchen Sink is Almost Empty

Chris Farrell Nov 7, 2007

Toggle bonds are back. Even as the major Wall Street firms and banks come clean on their subprime mortgage loans, investors are snapping up the riskiest of junk bonds. These so-called Toggle bonds let borrowers pay interest in cash or with more debt. The security was a poster child for how out-of-control the debt markets had become when so much cash was ignoring risk several months ago. No more.

Bloomberg has a good story on the return of Toogles:

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.

While Lehman Brothers Holdings Inc. estimates that mortgage losses will be as much as $250 billion in the next five years, the revival of toggles suggests that investors anticipate the economy will continue to grow and corporate defaults will stay near 25-year lows.

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 area bull market security,” she said.

The bonds accounted for about 18 percent of the $19.9 billion of new high-yield debt during October, up from an average of 8 percent in the first half of the year, when $8 billion were sold, Bloomberg data show.

Companies that issued the debt include Indianapolis-based auto-parts maker Allison Transmission, the Dallas-based power producer formerly known as TXU Corp. and human-resources manager Ceridian Corp. in Minneapolis.

One way of looking at this is investors are assuming that financial institutions with a big exposure to subprime losses are coming clean (finally) after the Merrill Lynch and Citigroup debacles. It’s kitchen sink time. Consequently, these same investors are betting that the news won’t tank the economy. If they’re right, its a shrewd bottom-fishing play.

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