Debt Liquidity Vacuum
Excerpts from Zerohedge's How to Profit from the coming High Yield meltdown.... which confirm our previous Natterings, in this seven part series, and in this two part series, and suspicions of a liquidity vacuum in the corporate, junk and HY debt markets.
"Banks, which have been slapped with onerous capital charges on low-spread synthetic instruments, no longer provide the bid for the top of the capital structure that they used to. In order to complete the capital structure, banks must now find a buyer for the senior and super-senior tranches that yield-hungry investors don't want.
Perhaps the scariest corner of the corporate credit market today is the market for corporate bond ETFs and open-ended mutual funds. These funds, such as the LQD, HYG, and JNK ETFs, provide daily liquidity to investors where the underlying collateral is much more illiquid corporate bonds. These funds are scary because liquidity has been tested in only one direction. Fund flows have been mostly one-sided over the past 5-6 years. Retail investors and institutions have been buying fixed income ETFs at a record pace in their search for yield and liquidity.
Who will take the other side when these massive flows reverse? The answer before the crisis would have been the banks. Now the answer is much less clear. The spate of recent failed placements in distressed loan markets is symptomatic of a liquidity vacuum.
Not only have banks reduced their own market-making activities in corporate bonds due to new onerous bank capital requirements, but banks have also wound down their repo financing businesses that are the lifeblood of cheap financing for non-banks to provide liquidity in corporate bonds."
The introduction of IOER (interest on excess reserves) and lower rates caused disintermediation on the part of the banks in this critical market making function. IOER resulted in compression of NIM (net interest margin) via a reduction in spread between borrowing short and lending long, which caused the banks to flee a no longer profitable venue i.e. lending in the short end of the yield curve.
"Banks, which have been slapped with onerous capital charges on low-spread synthetic instruments, no longer provide the bid for the top of the capital structure that they used to. In order to complete the capital structure, banks must now find a buyer for the senior and super-senior tranches that yield-hungry investors don't want.
Perhaps the scariest corner of the corporate credit market today is the market for corporate bond ETFs and open-ended mutual funds. These funds, such as the LQD, HYG, and JNK ETFs, provide daily liquidity to investors where the underlying collateral is much more illiquid corporate bonds. These funds are scary because liquidity has been tested in only one direction. Fund flows have been mostly one-sided over the past 5-6 years. Retail investors and institutions have been buying fixed income ETFs at a record pace in their search for yield and liquidity.
Who will take the other side when these massive flows reverse? The answer before the crisis would have been the banks. Now the answer is much less clear. The spate of recent failed placements in distressed loan markets is symptomatic of a liquidity vacuum.
Not only have banks reduced their own market-making activities in corporate bonds due to new onerous bank capital requirements, but banks have also wound down their repo financing businesses that are the lifeblood of cheap financing for non-banks to provide liquidity in corporate bonds."
The introduction of IOER (interest on excess reserves) and lower rates caused disintermediation on the part of the banks in this critical market making function. IOER resulted in compression of NIM (net interest margin) via a reduction in spread between borrowing short and lending long, which caused the banks to flee a no longer profitable venue i.e. lending in the short end of the yield curve.
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