Companies Paying Bond-Holders "In Kind"

In the non-profit world, there is a term called "payment-in-kind." That means an individual or company has supported a non-profit not with cash payments, but through donations of goods or services that the non-profit needs if it is going to operate. But when you bring payment-in-kind to the world of investing, you might also bring along the non-profit label - as in, this can be a great way of making nothing. According to the Financial Times, many companies have sold bonds with a PIK feature that allows borrowers to pay bondholders with shares or bonds rather than cash.:

During the buy-out boom, Standard & Poor’s Leveraged Commentary & Data estimates 43 bond deals were done with a PIK feature. Some analysts suspect, however, that the actual number was higher.

And now some of those companies are turning the concept into practice. This should be pretty damn disturbing to people who lend money to corporations. It's a credit crisis of a different kind.

In the past, when times were flush (at least on paper), companies often did not want to dilute ownership and its control and value. But what happens when a company can say, "Oh, that money we owed you? Here's another bond to make up for it." The bonds then effectively become IOUs, and when you expect to get cash, instead there is more paper. Companies may avoid default, but to what end? This turns credit ratings on their head, since, I'd argue, this lets borrowers effectively walk away from obligations in a legal manner. If compaies can, then often they will - and if they do, then the credit ratings that attempted to quantify how safe an investment was become meaningless.

Stock Market High Evidence of High Investors?

I shake my head, looking at the new Dow record: 14087.55. With Citigroup and UBS melting down, with other financial services firms only showing strength when the financial reports don't include the late summer, with housing taking a beating and Wal-Mart and Target and Home Depot feeling the pinch, with the Supply Management index being weaker than was expected (though still just above the contraction level), you might not think this was a time to be betting on stock market prices sitting at high levels. But, even as top grade bonds are doing well, so are equities. The Financial Times has an "explanation" from an analyst:

“Everyone’s expecting bad news but, once it’s out, it’s either not as bad as everyone thought or at least it’s out in the open,” said Richard Sparks, senior equity analyst and equity options trader at Schaeffer’s Investment Research.

“The expectation is still that there will be a rate cut when the Federal Reserve meets at the end of this month. The market has decided that it is going to happen.”

If ever there was proof that people are completely and unrepentantly nuts, this is it. There will be a Fed rate cut at the end of the month because the market has decided that there will be a Fed rate cut at the end of the month. If Sparks is right, then investors are walking right past investing, long beyond betting, and walking into the heart of the Faithful. Look at what the analysts are saying (again from the FT article):

The most significant economic data to come are the September payrolls figures due at the end of the week. Investors expect a rebound in job creation after the decline of 4,000 for August – the first fall in four years.

“We continue to expect overall payroll employment to be up 125,000 in September and look for little change in manufacturing jobs,” said Ted Wieseman, economist at Morgan Stanley.

Homebuilder stocks rose sharply on Monday after an analyst at Citi Investment Research said recent share price falls meant it was time to buy into the sector.

When you make your living leading the Faithful, I guess you can't afford to show doubt, even when that oncoming light in the tunnel is getting larger, and rounder, and there's the sound some equate to the roar of a tornado. The train is coming.