@adangut On first principles that’s true, but in practice not so much.
“I wrote something dumb on Tuesday about exchange-traded funds. Basically I said that if the Federal Reserve can buy a big corporate bond ETF as long as it doesn’t trade at a premium, but it can’t buy the underlying bonds (because their maturities are too long), then the obvious arbitrage to close any premium—buy the bonds and short the ETF—is risky because you are on the other side from the Fed; you end up owning what it doesn’t want and shorting what it does. But of course there is an easy obvious solution, it’s the whole point of ETFs: You buy the bonds, short the ETF, and then deliver the bonds to the ETF to create new ETF shares to deliver into your short. It’s fine, the system is set up to make the arbitrage work, never mind.” https://www.bloomberg.com/news/newsletters/2020-04-02/money-stuff-banks-have-too-much-money-now
@andyprior Fun article, not sure I agree that arbitrage will push up prices to sell to ETFs though; these ETFs individually do not hold large percentages of the underlying bonds so it would be hard to push up prices of the underlying no? Ive checked the underlyings for a few of the JNK holdings and the ETF doesnt hold more than 1% of any of the underlyings. Also another thing I forgot to mention earlier is that only 80% of the underlying bonds are american, 20% are foreign companies, not sure how involved the fed will really want to get given that structure...
@andyprior I've got puts on HYG as well. I have concluded from my research that the underlying securities in this ETF are at a pretty high risk of default, and by virtue of being high-risk junk bonds, they don't have any recourse. The Fed won't buy them, and the companies that are getting cash infusions are going to cover every other base before they worry about paying out their junk bonds.
One thing I found was that financial institutions like to short this ETF as a hedge. I'm not sure about this, and I want to hear what everyone else thinks, but my best guess is that this is a short squeeze - institutions are having to cover their positions and it's artificially driving the price up.
@brian1970 I mean they have the same recourse as any bondholder. They'll own the company coming out of bankruptcy most likely. The bigger issue with HY could be recovery values due to the amount of leverage coupled with the recent increase in leveraged loans. But that is going to take time to play itself out.
Companies that were distressed coming into this are likely done. Like a Frontier who has been on life support but its bonds were trading in the $50s before this so it has limited downside from there. This will just push them into bankruptcy.
I also disagree that the Fed won't buy them. I mean what do you think a TARP program will target? You have to remember the banks are also lenders to these companies so it will flow through the financial system. So I think the Fed would prefer not to cause a ton of bankruptcies.
Lastly, these cash infusions are definitely going to go towards interest payments. Otherwise they go bankrupt and equity goes to 0. Companies are going to service their debts and lease as much as they can. They'll only keep on employees and variable costs as much as they have to to qualify for the loans. They likely won't pay any maturities off in the near-term but how much is due in the near term? Lot of companies pushed out maturities.
