Here They Go Again: Wall Street Is Offering Debt-On-Debt-On-Debt!

Tyler Durden's picture

Submitted by David Stockman via Contra Corner blog,

Here’s how the daisy chain of debt works— short form. LBO’s issue debt—loads of it. Leveraged buyouts are now being priced at typical top-of-the-bubble ratios of 10X cash flow (“adjusted EBITDA”). The portion of these LBO debt towers that consists of bank term loans and revolver facilities is sold to freshly minted financial conduits called CLOs (for Collateralized Loan Obligations) which are not real companies and which do not have any money!

No problem. What happens is that credit hedge funds and Wall Street trading desk hit a computer key, open a new spreadsheet window, wrap it in legal boilerplate, provide this newly minted CLO with a credit line and then start bidding for available LBO paper in the junk loan market. When they have accumulated enough offers, they slice and dice the resulting portfolio of LBO loans, and issue multiple tiers of debt– with these new slices being rated from AAA to junk against the loans listed on the spreadsheet.

So we now have a spreadsheet, a part-time “portfolio manager” and hundreds of millions of the latest CLO toxic waste. For 95 weeks running, there was no want of buyers for this CLO issued paper. In its infinite wisdom, the Fed drove interest rates on CDs and high quality paper to nearly zero—–so the scramble for “yield” was on. Soon Grandpa was being forced to buy a high yield mutual fund in order to pay the light bills.

But now LBO risks are soaring due to recklessly escalating deal prices and also because the LBO kings are stepping-up their patented late cycle cash strip-mining operations in the form of “leveraged recaps” funded with new “cov lite” debt. So even yield starved retail investors have begun to turn tail and run. During the last two weeks there were actually outflows from high yield mutual funds.

That leaves a big gap in the market, however. The CLO jockeys are still banging out new spreadsheets, but buyers for the sliced and diced CLO paper are suddenly getting scarcer. Still, no problem!

Here’s why. 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!

Today’s Wall Street Journal article explains exactly how its being done. Needlessly to say, every one of the big banks back in the business got bailed out last time by TARP and the Fed. They seem to learn something—even if our policy makers never do...

By Katy Burne, Wall Street Journal


Banks again are doling out money to hedge funds and other investors to finance purchases of complex debt securities, returning to a practice that helped fuel the debt boom ahead of the financial crisis.

RBC Capital Markets, Société Générale ., BNP Paribas  and Wells Fargo are among the banks offering to let investors borrow money, also known as providing leverage, to buy collateralized loan obligations, say investors and bankers. CLOs are bonds typically backed by pools of low-rated corporate loans.


Borrowing programs for such esoteric securities have been only selectively available in the years since the crisis. While banks have lent to a handful of investors, the practice picked up late last year when funding costs began to fall….


Finding new buyers would help them offload the debt, while keeping prices relatively high. Some banks also are trying to ensure there will be demand for more CLOs they help create.


Banks “are resorting to creating economic incentives to get primarily hedge funds to step into this void,” said Oliver Wriedt, senior managing director at CIFC Asset Management LLC, which manages CLOs….


Hedge funds “have finally come to grips with leverage and begun to embrace it” for CLOs, said Jean de Lavalette, head of securitized products sales at Société Générale.


But with leverage comes risk. Even a small drop in the market could force investors to pledge more cash and other collateral to offset the securities’ decline. Losses are magnified when borrowed money is used….


…..GoldenTree Asset Management recently purchased CLOs using leverage. Joe Naggar, a partner at GoldenTree in New York, said using leverage makes sense because prices on highly rated CLOs have fallen, increasing their yield relative to other debt securities. Borrowing money to buy could bolster returns if prices rebound…..


Banks have offered to lend some investors as much as $9 for every dollar that the buyers invest in CLOs, say traders and strategists. Others are being offered $8 for every $2.


An investor in a triple-A-rated CLO earning 1.50 percentage point over the London interbank offered rate—using 10% of his or her own money and paying 0.80 percentage point over Libor for the financing—could earn about 8% in a year. That compares with annual interest rates near 2% on a standard triple-A CLO.


Citigroup researchers in a mid-April note to clients predicted that the new source of financing could help drive up prices of triple-A-rated CLOs.


That could be a boon to a market that has stumbled under the threat of new rules on what banks can hold on their books. CLO prices tumbled, and the creation of new CLOs slowed earlier this year as the market digested the rules that will ban banks from investing in certain CLOs.


Since then, CLO prices have begun to recover, and CLO issuance has picked up after a slow start to the year. More than $35 billion of CLOs were created so far in 2014, the most for that period since 2007, when $36.4 billion were created, according to S&P Capital IQ Leveraged Commentary & Data….


Read the Complete Article Here.

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So Close's picture

Rated triple A by who and why?

The Alarmist's picture

'cos tonite we're goin to party like its 1999  2005  2014, bitchez!

NoDebt's picture

And all this insanity is BETTER than just allowing the banks to go bust in 2008?


We could be exiting this period of insanity by now, not going deeper into it.  If this isn't the monetary Heart of Darkness, I don't want to know what is.

Parrotile's picture

Rated by those "Impartial" Western Ratings Agencies - the ones who were told to reduce the ratings of Russian Banks and associated institutions - "something to do with sanctions I believe"!

The Ratings Agencies have significant influence, therefore "power" in the Market. Governments (especially Western "Big Gov") are fully aware of this, and anyone would be a complete fool to "believe" that the Agencies are not told what to to, when, and to whom, by "those who pull the strings".

Independent, my foot! Not even a reliable "guide" to value!

disabledvet's picture

No less than Warren Buffet himself has said this same thing VERBATIM.

The theory that "in the end the totality of the War on Terror" is/was nothing more than a Total Return to the Subprime Slime is truly, truly, truly breathtaking.

I mean "the Fed is basically an unelected Government answering to no one"?


And terrifying as well.

We do have a Federal Government here...somewhere. It does exist. No less than Felix Solomon has pointed the truly dangerous path of simply "defaulting" so to speak to the Fed.

666's picture

I'm not worried because when it comes tumbling down, the taxpayers will bail 'em out again!


scuttlebutt's picture

This time around, the bailing bucket might have some awfully big holes in it.

Professor Fate's picture

If this happens again...where are you going to find a "taxpayer"?  The number is decreasing on a daily basis.  Better to unleash the "Bernank" and his magic exploding balance sheet.

Fate the Magnificent
"Push the Button. Max" 

blindman's picture
Loudon Wainwright - Dump the Dog and Feed the Garbage
The Faces - Ooh La La (1973).

love is blind/

you're far too kind/

don't ever let it show,

janus" janus

LetThemEatRand's picture

Hot debt-on-debt-on-debt action!  

Cattender's picture

Wall st = the most Immoral Assholes on the planet..

blindman's picture

i think the prefered term is amoral,
hence the worship of the machine, bypassing
any potential individual or collective
cognitive dissonance, leading to socialism
for the systemically amoral and fascism for the rest.
and it won't, will never and does not function or

luckylogger's picture

Fuking whores describes them and the politicians that back them. Just another way to fuk the retail guy or gal....

Dick Buttkiss's picture

You're forgetting the other W word, a little bit to the south, that creates the conditions for the rampant immorality and assholism that sustains them both.

SheepDog-One's picture

And the biggest above the law privileged assholes ever to exist.....the guillotines couldn't be wheeled out fast enough for these parasites.

yogibear's picture

Fail it and then Bail it agan. Rinse and repeat. 

Larger and larger debt. Too big to fail again. Jack Lew instead of Hank Paulson threatening.

SheepDog-One's picture

We learned our lesson, we swear we'll never never EVER do it again, if you just give us this bailout!
For fucks sake....I called this back in TARP days that they'd just do it again, on steroids and crystal meth!

i_call_you_my_base's picture

These fuckers better pray this works out, because the next time this goes awry we are coming for you.

SheepDog-One's picture

P.S.- People still aren't going to borrow from you so fuck yourselves Wall St!

BullyBearish's picture

They are also engineering something good for Russia:

U.S. in Talks With EU on Next Round of Sanctions on Russia  May 06, 2014 The U.S. is negotiating with European Union officials on a third round of sanctions to use against Russian industries if the former Soviet republic continues destabilizing Ukraine as it prepares for a May 25 election, two officials told Congress today.

“As the Kremlin’s decisions concerning the situation in Ukraine leave us with little choice but to continue to ratchet up the pressure, we will use the full range of sanctions authorities at our disposal, which will expose the weakness and vulnerability of the Russian economy,” Daniel Glaser, the Treasury Department’s assistant secretary for terrorist financing, said in testimony to the Senate Foreign Relations Committee in Washington.

While the U.S. has blocked access to U.S. markets for 45 individuals and 19 entities, including OAO Rosneft Chief Executive Officer Igor Sechin, it has yet to use the most significant sanctions -- those on financial, energy or mining industries.

Senators pressed testifying Obama administration officials, including Victoria Nuland, the State Department’s assistant secretary for European and Eurasian affairs, to use those broad measures before the elections.

Cohen’s Trip

The Treasury is “working tirelessly” to ensure the EU and the Group of Seven countries also continue to expand their measures, Glaser said. Treasury Undersecretary for Terrorism and Financial Intelligence David Cohen is traveling to Germany, France and the U.K. this week to discuss further steps.

“As the United States and our international partners continue to confront Russia’s illegal actions in Ukraine, we stand ready to further employ our arsenal of financial measures as the situation escalates,” Glaser said. “If Russia chooses to continue its illegal and destabilizing actions in Ukraine, we can impose substantial costs on, and expand the isolation of, an already weak Russian economy.”

Nuland said the administration is hopeful that in working with European officials, “we will have a strong package” of additional sanctions” and intend to “have them at the ready very soon.”

Besides economic sanctions, the tools Treasury is using include halting negotiations with Russia over an agreement that would help Russian financial companies comply with the Foreign Account Tax Compliance Act, a law passed by Congress in 2010 designed to prevent U.S. citizens from avoiding taxes by using foreign bank accounts.

‘Strong Penalties’

Without a bilateral agreement between the two nations, Russian banks will have to register with the U.S. Internal Revenue Service. While some might be able to do that, others that won’t face “strong penalties,” Glaser said today. Companies that don’t register with the IRS face a 30 percent withholding tax on payments from the U.S. starting July 1.

“The Treasury Department at this point has no intention of restarting negotiations with Russia,” he told the committee.

Without the agreement between the two nations, it will be “expensive and difficult” for the Russian banks to comply with the tax law, also known as FATCA, VTB Group chairman Andrey Kostin said last month.

While pressing Russia to change its course, the international community is providing support for Ukraine. Financial aid provided to the country this month is estimated to reach $5.9 billion, including $3.2 billion from the International Monetary Fund and an estimated $2.7 billion from the U.S., European Union, World Bank, Japan, and Canada, Glaser said.

VIDEO: EU, U.S. Threaten Russia With Tougher Sanctions

Asked about whether punitive steps against Russia might involve credit-card companies Visa Inc. (V:US) and MasterCard Inc. (MA:US), Glaser said “we have a number of tricks up our sleeve” and the “credit-card idea that you are articulating is certainly one of the levers that we have with respect to Russia.”

Visa and MasterCard play a “significant” role in the financial system in Russia, Glaser said.

bam's picture

oh gawd, CDOs AGAIN? you gotta be kidding me

Luckhasit's picture

Stacks on stacks on stacks!

WTFUD's picture

Rating Agencies are now OBSOLETE!!! Why do they still exist?

dutchTender's picture

the junk bond carry trade  :)  bernankee wanted risk, and risk he shall have. as obama once said about russia, history will not look back kindly on casino ben.

NOTaREALmerican's picture

I'm not worried,   Greenspan himself said the banks were self-regulating; because the invisble hand of the free-market is honest when it comes out of the shirt sleeve of a banker. 

Lone_Star's picture

Aaa means so much more now that the US will bring charges against any agency that dares to question the genius of $17 Trillion+ in debt with no end in sight.

Docnyc's picture

Wall Street meth labs (as per a previous stockman article)

khakuda's picture

There are few angels on Wall Street, but no one should forget the devil on the shoulder of these guys is the Fed who gets 90% of the blame in my book.  The Fed is the enabler.  This time around, Bernanke/Yellen are intent on keeping money free until Wall Street bends everyone over for another round of butt sex.

AdvancingTime's picture

The more and more I study derivatives it now appears the main goal of QE may have been to hold up the underlying value of assets that feed into and support the massive derivative market more than help the economy. QE has up to now stopped an implosion of derivatives and the resulting contagion and shock that would have spread throughout the financial system.

Paul Wilmott from Oxford University estimates the derivatives market at $1.2 quadrillion, to put that in perspective it is about 20 times the size of the world economy. The point of the article below is to call attention to the insanity of derivatives as an instrument or tool to add stability to our financial system. By stacking risk upon risk and transferring it off to another party who may not be able to preform you do not increase stability.

Obamanism's picture

So leave my money in the bank and get 0.8% interest (with the possibility of losing 40% in the bail-ins AKA Cyprus)

Invest in the above get 8.00% return  (loose 90% when the SHTF)

Decisions Decisions.

I like shiny things, so I will buy the Barbarous Relic to look at.

AnfiskaPritch's picture

 Debt is a big burden to the economy of any country. This is the task of government’s strategy to reduce the volume of the debt so that social and economic situation would be stabilized. Financing borrowers with low credit will be rather helpful in the wide range of life circumstances.