LBO Multiples: The Latest Credit Bubble 2.0 Record
This week marked what we suspect will become an important inflection point when the world looks back at this debacle of a bubble. The Fed, having already warned in January of 'froth' in credit markets (and ths the fuel for 'hope' in stocks) proposed tougher underwriting standards for leveraged loans. Credit markets have underperformed since; but as Diapason Commodities' Sean Corrigan notes, the baleful impact of the central banks is still everywhere to be seen in the credit markets. From junk issuance to the rapid regrowth of the CDO business to the 'record' high multiples now being exchanged for LBOs; Central Banker's monomaniacal fixation on zero interest rates and artificial bond pricing is setting us up for the next, great disaster of misallocated capital and malinvested resources.
Any 'popping' of the credit bubble will be massively destructive to stocks - as we warned here, this is Carl iCahn's worst nightmare...
...But we have seen this "credit cycle end, equities ramp" before - in 2007 - where leverage (both firm-wise (debt/EBITDA) and instrument-wise (CDOs)) provided the extra oomph to send stocks higher on the back of credit fueled extrapolation of earnings trends.
In the end we know this is unsustainable - the question is when (in 2007 it last 10 months or so...).
We already see 30Y Apple bonds trading at 5% yields - admittedly low still but notably higher than when they issued previously. The Verizon deal recently now trades at around 5.7% yield and is considerably worse financially pro forma. Of course, just as in 2007, things change very quickly once collateral chains start to shrink.
Perhaps this is why Carl iCahn said the Apple CFO/CEO shunned him - iCahn's worst nightmare is simply the inability to proxy-LBO each and every firm...
Given these charts - which market do you think is in a bubble - equity or credit? Bear in mind that the Fed's Jeremy Stein has already made his case that the latter is a bubble for sure... and the fragility that reaching for yield creates...
But the signs of an even bigger bubble are clear...
Via Sean Corrigan of Diapason Commodities:
The Taper fiasco may have delivered a temporary fright, but this has not yet been sufficient to bring about a more lasting reappraisal. With junk yields having retraced half their 180bps spike ? and so reaching territory only ever undercut at the very height of the wild enthusiasm of the first half of this year—and with the CDX index pretty much back to its post?Crisis best, it can only be a matter of time before issuance volumes swell once more.
Even with the last few months’ abatement, this has hardly been a market in dearth, as you can see from a sampling of the comments made by Thomson Reuters in its review of the third quarter:?
The volume of global high yield corporate debt reached US$350.2 billion during the first nine months of 2013, a 27% increase compared to the first nine months of 2012 and the strongest first three quarters for high yield debt activity since records began in 1980... Issuance from European issuers more than doubled compared to the same time last year.
Nor was the gold rush restricted to bonds, per se:?
Overall Syndicated lending in the Americas… increased 34.9% from the same period in 2012, with proceeds reaching US$1.8 trillion… Leveraged lending in the United States increased markedly from the first nine months of 2012, totalling US$894.8 billion... representing an 81.5% increase in proceeds.
And, to add to the thrills—They?y?y’r?r?e Back! Yes, CDOs and CLOs are enjoying a renewed vogue just five short years after they played a key role in blowing up the world’s financial system:?
Global asset?backed securities totalled US$251.3 billion during the first nine months of 2013, a 7% increase compared to the same time last year and the best annual start for global ABS since 2007. Collateralized debt and loan obligations totalled US$62.3 billion during the first nine months, more than double issuance during the first nine months of 2012. CDO and CLO volume accounted for one quarter of ABS [volume].
As the good folks at PitchBook also pointed out, this was no time to be sitting on the sidelines in the LBO world, either:?
Corporations’ appetite to utilize cheap debt manifested itself in an average leverage ratio of 61.8%... a postfinancial?crisis high (2007 was 67.6%). Another important development has been the rapid increase in valuation?to?EBITDA multiples for buyout deals, which hit a decade high of 10.7x in 2013.
In a summation which perfectly encapsulates how the CBs’ monomaniacal fixation on zero interest rates and artificial bond pricing is setting us up for the next, great disaster of misallocated capital and malinvested resources, one Margaret Shanley, a principal at Cohn?Reznick, opined that:?
“...it is no surprise that valuations have remained at robust levels this year, several factors are at play supporting the increase—high demand and low supply for quality deals and easy access to debt with historically low pricing...”
? the first two features being a direct consequence of a set of policies expressly fashioned to bring about the last one cited, one hastens to add.
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