Should You Buy Junk Bonds?

06/11/2012 11:45 am EST

Focus: BONDS

Marilyn Cohen

President & CEO, Envision Capital Management, Inc.

The only way to find decent yields these days is in the junk-bond market, says Bond Smart Investor’s Marilyn Cohen, who shares some specific bonds that she likes now.

Junk bonds: where the action is? We’re here with Marilyn Cohen, who’s going to talk to us about the junk-bond market.

Well, it is where the action is, because that’s where the yield is when you compare and contrast with investment-grade bonds. If you’re going to buy short-term investment-grade quality bonds, seven years and under, you’re lucky if you can get 2%

Whereas high-yield bonds—companies who have redone their balance sheet, done a makeover of their balance sheet—they’re in good shape now, and those yields aren’t certainly as juicy as they used to be. But getting a 5%, 6%, or 7% on a junk bond in which they have cash, they have backlogs, and they have real earnings potential is what the market is looking at now, and I think that that’s where the value is.

Is it a bargain? No. Junk land is not a bargain, but there certainly are some good yields out there with a modicum of safety, and that never used to be the situation.

Right, and I guess it’s a good time if you expect the economy to expand; generally that’s a good time to get into junk bonds because as the economy gets better these companies get healthier, and they grow, and then they can refinance their debt, and the bonds become even more valuable, correct?

That’s exactly right. I don’t expect there to be a lot of growth in the economy, but if the economy continues to chug along at 2% or 2.5% GDP…they have made their projections, these junk bond issuers, based on a kind of a moderate growth, and they can continue to still make money, have excess money over their interest costs.

I’m not saying that they’re going to crawl out of being junk. Many of them want to stay junk because they like that levered balance sheet. But they’ll certainly survive. And the default rate in junk land still is extremely low; it’s 2% or lower depending upon which sector you look at, and that’s pretty phenomenal going year after year with such a few amount of defaults.

Right, and, with that kind of yield.

Exactly. Like I said, there are no bargains, but you can ferret out the good versus the bad.

There are a lot of junk-bond funds, both exchange traded funds like the SPDR Barclays High Yield (JNK), there are some open-end funds, and there are even some leveraged funds. With money being almost free, short-term money leveraging in the closed-end fund market kind of makes sense for those who want to take a little bit of extra risk.

Are there any particular bond issuances that you like?

Oh, glad you asked that; yes there are.

CIT Group (CIT), the finance company, has been the turnaround story of this decade. I pounded the tables in 2010 on CIT. I pounded them in 2011 to buy the 7% due in 2013, 2014, 2015, 2016, 2017, and they’ve called all of those bonds now. I’m happy to say that was the easiest 7% me and my clients ever made.

But now the story is a little bit more mature; they have some 5% bonds due in 2017, yielding around 4.85%. I still think that’s value for a bond that’s relatively short-term, so we like CIT.

Here we are in Las Vegas, and I like Wynn Las Vegas (WYNN) for some mortgage bonds. Those yields are around 4.85% to 2015, about 6% to 2020 if they last that long.

If Wynn happens to stumble big or go into bankruptcy, we bondholders own the first mortgage on the facility here in Vegas. I think that there’s real value there. So, we would get, like 97 cents on our dollar.

So, there are specific names out there with decent balance sheets that aren’t overleveraged that I think people can make some money in.

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