Yay. Sales of another ticking-bomb "financial instrument" on the rise

[charlie]

Step-up bonds. If a borrower is on sound footing, he owes less. If his finances go wobbly, he owes more. THAT'LL learn him. Sheer genius!

Markets are over-fond of protection, with most of it is wearyingly pro-cyclical. Way back when it was portfolio insurance, but now "step-up bonds" are on the rise.

These nifty things cause interest rates to increase as a result of credit downgrades. For example, Lafarge has step-up bonds whose coupons rise by a predetermined 1.25-percent if the cement company's credit is downgraded to junk. Nice protection, huh? The trouble is, of course, that a downgrade usually reflects worsening company financial health, which makes increasing the interest payments sort of like giving a good, hard shove to someone who has wandered close to a cliff's edge.

Here's the latest on investor ardor for such things:

Bonds with built-in protection against rating cuts are making up a record share of debt issues as investors hedge against a slowdown in the economic recovery.

...Sales surged to $37.3 billion in March, or 12.4 percent of all debt issued, according to data compiled by Bloomberg. Most of the notes are sold in the U.S., where almost half of bonds rated as so-called junk or on the cusp of non-investment grade include the protection.

...Sales of the bonds globally are up from $16.6 billion in February and $8.4 billion a year ago, according to Bloomberg data. In the U.S., such borrowers sold a record $32 billion of the debt last month, or 46 percent of all bond issuance, the data show.

http://www.bloomberg.com/apps/news?pid=20601087&sid=a8lsONr2.Qq0&pos=3

http://paul.kedrosky.com/archives/2010/04/step-up_bonds_a.html