Collateralized Loan Obligations
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!
- Fed’s Fisher Says Economy Strengthening as Payrolls Rise (BBG)
- Russia Knows Europe Sanctions Ineffective With Tax Havens (BBG)
- EU Cuts Euro-Area Growth Outlook as Inflation Seen Slower (BBG)
- U.S. Firms With Irish Addresses Get Tax Breaks Derided as ‘Blarney’ (BBG)
- Portugal exits bailout without safety net of credit line (Euronews)
- Puzzled Malaysian Air Searchers Ponder What to Try Now (BBG)
- Barclays, Credit Suisse Battle Banker Exodus, Legal Woes (BBG)
- Germany says euro level not an issue for politicians (Reuters)
- Alibaba-Sized Hole Blown in Nasdaq 100 Amid New Stock (BBG)
- Obamacare to save large corporations hundreds of billions (The Hill)
This eruption of late cycle bubble finance hardly needs comment. Below are highlights from a Bloomberg Story detailing the recent surge of leveraged recaps by the big LBO operators. These maneuvers amount to piling more debt on already heavily leveraged companies, but not to fund Capex or new products, technology or process improvements that might give these debt mules an outside chance of survival over time. No, the freshly borrowed cash from a leveraged recap often does not even leave the closing conference room - it just gets recycled out as a dividend to the LBO sponsors who otherwise hold a tiny sliver of equity at the bottom of the capital structure. This is financial strip-mining pure and simple - and is a by-product of the Fed’s insane repression of interest rates.
Over the weekend, there has been some consternation over the report that the CEOs of the 6 largest US banks: JPM, BAC, GS, MS, C and WFC, collectively made $96.1 million in 2013, more than $86.3 million the year before and the most since the financial crisis. However, we are confident those same people would have an aneurism if they were to learn that James "Jimmy" Levin, a 31-year-old hedge fund trader - head of global credit and an executive managing director at Och-Ziff - last year made a whopping $119 million, or more than all of the CEOs of the six largest firms combined.