Collateralized Loan Obligations
Junk Contagion Spreads: Investment Grade Bonds Plunge To 2-Year Lows, Treasury Liquidity Collapses, CLOs NextSubmitted by Tyler Durden on 12/14/2015 14:49 -0500
First it was just junk, then investment grade bonds started getting whacked, then liquidity in the 10Y Treasury imploded, and now CLOs are getting hit: “The price declines are alarming and worrying," according to Rishad Ahluwalia, JPMorgan’s head of global CLO research.
Currently, there are things occurring that are very troublesome, and in more normal times, would likely already have investors heading for cover. However, in today's liquidity fueled, Central Bank supported environment, that has yet to be the case. The reason was best described recently by Dr. Robert Shiller "I call this the 'new normal' boom ó it's a funny boom in asset prices because it's driven not by the usual exuberance but by an anxiety." What happens next is only a guess. However, historically, it hasn't been the outcome that investors were hoping for. But then again, maybe "bearish bull" isn't as much of an oxymoron as it is just a warning.
Sense of desperation among CEOs?
Wall Street turns junk-rated US corporate loans into highly rated yen-denominated bonds. Desperate Japanese pension funds gobble them up. Blame the Bank of Japan.
March was a record month for CLO issuance with $15.2 billion in deals coming to market, bringing the YTD total to $29 billion and making Q1 2015 the best first quarter in history for CLO new issue volume. And while a JPM analyst who spoke to Bloomberg says managers “want to get deals done early before risk retention kicks in,” we're confident that it’s all about keeping credit flowing to deserving borrowers and not at all about a desire to keep exposure to 5% of a collateral pool littered with loans to “companies that are of lower credit quality or that do not have a third-party evaluation of the likelihood of timely payment of interest and repayment of principal” off of the books.
This morning I had left the TV mistakenly tuned to CNBC with the sound on - and unavoidably caught another bullish strategist jawing about the US economy’s awesome strength. This one was peddling as exhibit #1 the recent surge in C&I loans, arguing that it is a sure sign that business is gearing up for a post-winter boom. In this case, like most of the blizzard of bullish factoids spewed out each day on bubble vision, the purported business lending boom is not all that.
When an economic crisis is coming, there are usually certain indicators that appear in advance...
"This is why Putin is Public Enemy Number 1. It’s because he’s blocking the US pivot to Asia, strengthening anti-Washington coalitions, sabotaging US foreign policy objectives in the Middle East, creating institutions that rival the IMF and World Bank, transacting massive energy deals with critical US allies, increasing membership in an integrated, single-market Eurasian Economic Union, and attacking the structural foundation upon which the entire US empire rests, the dollar." Up to now, of course, Russia, Iran and Venezuela have taken the biggest hit from low oil prices; but what the Obama administration should be worried about is the second-order effects that will eventually show up...
Among those who’ll get to eat the losses: unsuspecting retail investors.
Marty Fridson, CIO at Lehmann Livian Fridson Advisors, has been a leading figure in the high-yield bond market since it was known as the "junk bond" market — and he sees as much as $1.6 trillion in high-yield defaults coming in a surge he expects to begin soon... “And this is not based on an apocalyptic forecast,” he warns.
The attached Barron’s article appeared in December 2007 as an outlook for the year ahead, and Wall Street strategists were waxing bullish. Notwithstanding the advanced state of disarray in the housing and mortgage markets, soaring global oil prices and a domestic economic expansion cycle that was faltering and getting long in the tooth, Wall Street strategists were still hitting the “buy” key. In fact, the Great Recession had already started but they didn’t have a clue: "Against this troubling backdrop, it’s no wonder investors are worried that the bull market might end in 2008. But Wall Street’s top equity strategists are quick to dismiss such fears."
The total tonnage of economic malarkey being shoveled over the American public these days would make the late Dr. Joseph Goebbels (Nazi Minister of “Public Enlightenment and Propaganda”) turn green in his grave with envy. It’s a staggering phenomenon because little about it is conspiratorial; rather, it’s the consensual expression of a public that wants desperately to believe things that are untrue, and an economic leadership equally credulous, unmanned, and avid to furnish the necessary narratives that might preserve their jobs and perqs.
It wasn’t an edgy blogger but the Office of the Comptroller of the Currency that issued the warning.
If the Fed is looking for definitive proof of bubble euphoria it should look no further than the CLO market: according to Bloomberg, so far in 2014, more than $46 billion of collateralized loan obligations have been raised, after $82 billion were sold in all of 2013. As a result of this epic dash for repackaged trash, JPMorgan boosted its annual forecast for CLO issuance from $70 billion to as much as $100 billion, which means 2014 may end up as the biggest year on record. We assume it is with great irony that Bloomberg summarizes: "The business of bundling junk-rated corporate loans into top-rated securities is booming like never before after the implementation of regulation aimed at making the financial system safer."
Wall Street is back in the business of lending money at the Fed’s gifted rate of zero plus a modest 80 basis point spread - so that the fast money can buy CLO paper on 9 to 1 leverage. There is your triple shuffle. It didn’t work out last time, but that doesn’t matter because the game is obvious. After enough buying on Wall Street’s triple leverage, junk loan prices might temporarily rebound. Then the brokers will put out the call to retail: The junk loan asset class is rebounding - its time to come back. For the final shearing, that is!