High Yield Is High Yield No Matter How You Securitize It

High Yield Is High Yield No Matter How You Securitize It

High Yield debt is High Yield because of the underlying risk profile of the issuer. “Whole Business” securities masked this risk – and won High Grade status – by pledging additional assets. Guess which security type is blowing up?

High Yield debt is High Yield no matter how you package it. High Yield issuance exploded some 20-plus years ago. I lived through it in Putnam’s High Yield operation where we owned debt issues from risky companies such as Global Crossing during the Telco boom. It was during this period (mid-to-late 1990s), that mortgage-backed securities started to explode.

The mid-2000’s took High Yield debt issues to another level. Mortgage loans that should have never been extended were packaged with high grade debt obfuscating the underlying High Yield risk. These bogus “High Grade” mortgage-backed securities (“MBS”), exploded causing the 2008 financial crisis. Read “The Big Short” (link below).

We did it again in 2019. Smart people ignored their better judgement in an effort to generate yield. Yield is scarce as interest rates are maintained at artificially low levels for political reasons. What happened? Companies securitized everything, including that which was bolted down in an effort to generate yield. Risky businesses such as food chains, preschools, music royalty distributors and even massage parlors – traditionally High Yield issuers – essentially pledged their entire businesses as collateral. These quirky debt issues are known as “whole-business” securities and reached record levels in 2019. The odd thing is that many of these debt issuances won High Grade status simply because more assets were pledged as collateral, ignoring issuers’ underlying risk profiles.