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N O R T H E R N T R U S T G L O B A L I N V E S T M E N T S High Yield Fixed Income Update June 30, 2008 Edward Casey Richard Inzunza, CFA Fund Managers, Northern High Yield Fixed Income Fund © 2007 Northern Trust Corporation northerntrust.com High Yield Update Agenda 2 Review of Current Environment High Yield Market Outlook High Yield Fixed Income Management High Yield Environment Review 3 In 2007 high yield default rates & spreads reached historic lows following strong economic growth and accommodative credit creation from structured markets ( please see OAS and default charts) Problems in the housing market severely impaired structured credit markets and caused financial markets to cease functioning properly The systemic disruption culminated in a liquidity crisis that threatened the imminent failure of Bear Stearns. The Federal Reserve helped to structure the rescue of Bear Stearns by J.P. Morgan, aided by credit available directly from the Federal Reserve In response to the financial market turmoil the Federal Reserve lowered the Fed Funds target by 325bps, including a 75bps inter-meeting move. Several liquidity measures were introduced by the Federal Reserve, ECB and Bank of England to ease market liquidity tensions Credit market sentiment cautiously recovered early in the second quarter as financial institutions were able to raise additional capital through the issuance of common equity, preferred stock and hybrid securities. Bank capitalization remains weaker than before the crisis and lending standards have tightened considerably (please see C&I lending chart) High Yield Fixed Income Management High Yield Environment Review - High Yield Index Spreads High Yield Market Option-Adjusted Spread (OAS) 1100 1050 March 17th 815bps 1000 950 900 1998 to 2003 645bp 850 800 750 700 20 year avg 475bp 650 10 year avg 517bp 600 550 500 450 400 350 2007 low 231bps 1993 to 1998 avg 326bp 300 250 Source: Lehman Brothers 2% Capped Index, June 2008 4 High Yield Fixed Income Management Oc t-0 6 Au g07 Ju n08 Oc t-0 1 Au g02 Ju n03 Ap r-0 4 Fe b05 De c05 Oc t-9 6 Au g97 Ju n98 Ap r-9 9 Fe b00 De c00 Fe b90 De c90 Oc t-9 1 Au g92 Ju n93 Ap r-9 4 Fe b95 De c95 -88 r-8 9 Ap Ju n Au g87 200 High Yield Environment Review – Moody’s Default Rate 20-year Moody’s Global Default Rate Average 4% 12.0 11.0 10.6 10.4 10.0 10.0 9.0 8.4 8.0 7.0 6.0 6.2 6.1 5.7 5.6 5.0 3.5 4.0 3.9 3.8 4.3 3.6 3.5 3.3 3.0 2.0 5.3 4.9 1.8 1.0 1.9 1.6 1.3 0.4 3.4 3.3 1.6 2.4 2.0 1.7 1.7 1.0 0.7 0.0 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 Source: Moody’s, December 2007 5 High Yield Fixed Income Management 1999 2001 2003 2005 2007 High Yield Environment Review – Tightening Lending Standards Tightening Standards for Commercial & Industrial Loans (Small Companies) versus High Yield Spreads 1050 75 1000 65 950 900 55 850 800 45 750 700 35 650 600 25 550 500 15 450 400 5 350 300 -5 250 200 -15 150 C&I (RHS) OAS (LHS) Source: Federal Reserve Survey, April 2008, Lehman Brothers June 2008 6 High Yield Fixed Income Management -08 Ju n Oc t-0 7 -06 Fe b-0 7 Ju n Oc t-0 5 Fe b-0 5 -04 Ju n Oc t-0 3 -02 Fe b-0 3 Ju n Oc t-0 1 Fe b-0 1 -00 Ju n Oc t-9 9 -98 Fe b-9 9 Ju n Oc t-9 7 Fe b-9 7 -96 Ju n Oc t-9 5 Fe b-9 5 -94 Ju n Oc t-9 3 Fe b-9 3 -92 Ju n Oc t-9 1 -25 Fe b-9 1 100 High Yield Market Outlook 7 The disruptions in the financial and banking system are likely to result in a reduction in the availability of credit to all areas of the economy This reduction in credit is expected to have a negative impact on spending in the broader economy. The reduction in demand will reduce earnings, with HY companies the most at risk The risks to growth are skewed to the downside given the multitude of headwinds facing the economy; weak residential market, tightening lending standards, weakening labor market, high commodities prices and low consumer confidence The transition from a financial/banking system disruption to a problem in the broader economy is expected to occur in a two-stage process in which the impact to the broader economy lags the financial system by 6 to 9 months. Therefore, the impact to the broader economy should continue through 2008 The safety net of "free money" that had artificially suppressed the default rate over the past few years is no longer available to support distressed companies High Yield Fixed Income Management High Yield Market Outlook (continued) 8 Weaker issuers are expected to breach financial covenants. Lenders are expected to seek increases in effective interest rates, a floor on LIBOR and waiver fees The default rate is likely to increase due to the normal seasoning cycle. A further reduction in credit availability will add pressure to the default rate going forward The HY index at 689 on June 30 was within the 675-725 six month target range set by Northern Trust Global Investment’s Credit Strategy Committee. HY portfolio management expects negative earnings to pressure spreads as the earnings cycle progresses. However, a significant widening beyond 1,000bps is not expected in the near term due to lower risk of systemic failure High Yield Fixed Income Management Important Information The preceding discussion is general in nature, is intended for informational purposes only, and is not intended to provide specific advice or recommendations for any individual or organization. Because the facts and circumstances surrounding each situation differs, you should consult your attorney, tax advisor or other professional advisor for advice on your particular situation. There are risk involved with investing, including possible loss of principal. The information in this communication has been obtained from sources considered reliable, but we do not guarantee that it is accurate or complete. Additional information is available upon request. The Lehman U.S. Corporate High Yield 2% Issuer cap Index is an unmanaged index that is not available for direct investment. Past performance is no guarantee of future results. NOT FDIC INSURED 9 High Yield Fixed Income Management NO BANK GUARANTEE MAY LOSE VALUE