Zero-Coupon Bond Index Nears Zero Bonds
11:58 am ET March 26, 2020 (Dow Jones)
By Sebastian Pellejero
A pillar of the 1980s leveraged-buyout boom is on the verge of extinction.
At the start of the year, just three companies remained in the ICE BofA U.S. High Yield Deferred Interest Bonds index, which tracks so-called zero-coupon corporate bonds from low-rated companies. Those are bonds that don't make regular interest payments. Instead, investors buy them at a deep discount, receiving their full face value all at once when the bonds mature.
But defaults early this year by newspaper owner McClatchy Co. and oil-and-gas firm Tapstone Energy LLC left debt from Foresight Energy LP as the sole component in the index. But St. Louis-based Foresight, which produces coal in the Illinois Basin, filed for bankruptcy just weeks ago, leaving the index with zero bonds in it at the end of month.
The demise of the zero-coupon bond index highlights the decline of a financial product that once helped fuel the leveraged-buyout boom of the 1980s, said Marty Fridson, chief investment officer at Lehmann, Livian, Fridson Advisors LLC.
During the LBO boom of 1980s Wall Street, buyers often paid for companies by selling large amounts of debt at relatively high interest rates. Zero-coupon bonds gave companies time to grow before they had to pay it back.
Now, with interest rates low, investors typically contribute much more equity to buyouts and borrow using the high-yield bond and leveraged-loan markets, which have grown to trillions of dollars over the past decade.
"The conditions that gave life to zero-coupon bonds have largely passed -- you don't have to resort to zero-coupon or payment-in-kind bonds to support the capital structure," Mr. Fridson said. "At the same time the exuberance around leveraged buyouts has tempered. People saw the dangers of excessive leverage."
Don't count out a comeback for the index or zero-coupon junk bonds, said Mr. Fridson. After shrinking to zero companies in June 1997, the ICE BofA High Yield Pay-In-Kind index, which allows companies to defer cash interest payments, grew to an all-time record of 53 in December 2013.
Other analysts are more skeptical.
"Investors demand cash flow, so zero-coupon corporate bonds have fallen out of fashion," said Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC. "Anyone could issue a zero-coupon bond. It doesn't necessarily send a great signal about a company's cash-flow prospects."
