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Mal-Investment Mania - The Second-Lien Scramble Is Back

Tyler Durden's picture




 

The zombification of corporate America is nowehere more evident than the yield-starved demand that has enabled companies with the lowest of the low credit ratings to raise debt capital and stay alive far beyond their 'natural' lifespan. As WSJ reports, investors are gobbling up some of the riskiest debt from junk-rated European companies at the fastest pace in years. The riskiest tranche of that debt - so-called second-lien, or junior, loans - amounts to $3.3 billion, almost double the amount raised at the same stage last year and the most over the same period since 2007. The reason is simple - Central Banks - "If you have more demand than supply then you end up with a loosening of terms and potentially more leverage and more aggressive structures."

 

As WSJ reports, investors are gobbling up some of the riskiest debt from junk-rated European companies at the fastest pace in years.

Companies with lower credit ratings have raised $186 billion in junk loans so far this year, according to Dealogic. The riskiest tranche of that debt—so-called second-lien, or junior, loans—amounts to $3.3 billion, almost double the amount raised at the same stage last year and the most over the same period since 2007.

This is not simply a dash for trash - this is the absolute lowest of the low in the capital structure...

If a borrower goes bust, junior lenders are only repaid if some other, higher-ranking lenders, get all their money back. Only unsecured creditors and shareholders are further down the queue. Companies also get better terms—junior loans are less restrictive when it comes to taking on additional leverage than senior debt, while borrowers get more flexible repayment options than bonds.

 

In exchange for the additional risk, investors get a better return. Interest rates on junior loans are typically 3.5 percentage points higher than senior loans, bankers say.

The reason is clear...

The rise in junior-loan issuance comes as loose monetary policy from central banks has depressed yields, pushing some investors into riskier assets that offer higher yields.

 

"If you have more demand than supply then you end up with a loosening of terms and potentially more leverage and more aggressive structures," said Elissa Johnson, a fund manager at Henderson Global Investors, which oversees around £1 billion ($1.66 billion) of loan assets.

 

Dealogic data show that more than half the loans that include junior debt have been used for acquisition financing, with a smaller proportion financing dividend payments.

And it's not slowing down - yet...

Meanwhile deal sizes are getting larger too. Last month, Spanish private hospital operator IDCSalud raised €2.15 billion in junk loans, €350 million of which was in junior debt, the largest junior deal from a European company in three years.

 

"We're seeing more and more requests from companies for these type of deals,"

Oh - and by the way - the risk is enormous...

Losses on junior loans can be steep if a company fails. The average recovery rate on defaulted junior loans in Europe between 2003 and 2013 was 36%, according to Standard & Poor's. That compares with 76% on senior loans, S&P data show.

So be sure that extra 350bps of yield covers your 64% capital loss potential...

*  *  *

This is 'mal-investment' writ large, and at least as bad as during the 2007 bubble.

*  *  *

The only thing is... credit investors are getting antsy again...

 

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Sun, 08/24/2014 - 18:04 | 5138172 Deathrips
Deathrips's picture

Paper...Get your worthless promises here...paper!!

 

This is shit.

 

RIPS

Sun, 08/24/2014 - 18:05 | 5138184 X.inf.capt
X.inf.capt's picture

NO JOKE!

this is not going to end well, AGAIN!

Sun, 08/24/2014 - 21:21 | 5138757 RiderOnTheStorm
RiderOnTheStorm's picture

Losses on junior loans can be steep if a company fails. The average recovery rate on defaulted junior loans in Europe between 2003 and 2013 was 36%, according to Standard & Poor's.

 

Being the stand up gut that I am, all these folks can lend me a Billion Dollars and I will personnally guarantee a 37% payback!!! 

Sun, 08/24/2014 - 21:19 | 5138766 IANAE
IANAE's picture

No kidding... only 350 bps spread to senior secured? Must be investing with OPM...

Sun, 08/24/2014 - 18:11 | 5138193 junction
junction's picture

Are these junior loans any better than mezzanine loans?  By the time these loans vaporize, the cash will have been divvied up and vanished into some Cayman Island corporate hole.  Meanwhile, as the Obummer administration prepares for more war, someone here posted this very interesting link:

http://henrymakow.com/2014/08/ISIS-are-Sunni-Impostors%20.html#sthash.Fs...

Sun, 08/24/2014 - 18:05 | 5138178 ShortTheUS
ShortTheUS's picture

Sounds a lot like CDO's during the housing boom/bust.

Mon, 08/25/2014 - 01:33 | 5139413 FreedomGuy
FreedomGuy's picture

Those were income streams. I remember analyzing a mutual fund portfolio which had a lot of these and it struck me as odd that the rates were higher than the underlying loans. I was sure I was misunderstanding something.

Sun, 08/24/2014 - 18:11 | 5138196 OC Sure
OC Sure's picture

OT, but does anyone know why CME stuff has a delayed opening?

Sun, 08/24/2014 - 18:12 | 5138197 Muppet
Muppet's picture

This week, Hussman thoroughly critiqued the FED.  Very comprehensive.  http://hussman.com/wmc/wmc140825.htm

Sun, 08/24/2014 - 18:31 | 5138252 GooseShtepping Moron
GooseShtepping Moron's picture

Thanks for that link. I've skimmed through it and it looks great. I'll enjoy reading it later this evening.

Sun, 08/24/2014 - 19:44 | 5138209 WillyGroper
WillyGroper's picture

Tyler's, ekm1, Churchill,

can someone help me out here? I did a search of the DTCC - Cede & co here. The article mostly referenced derivatives. We know the casino is rigged, but this is an illusion I could never have dreamed of. If this man is correct, the 1st derivative is book entry stock. MERS wiped out deeds unless you hold them in your hot little hand. Stockman tells you to hold equities in certificate form. Obviously this is why. According to this guy, try getting one. It's long, but I think worth the time. It sounds to me the market matters not, it's going to boil down to property seizure & banking holiday's/capital controls/martial law. The EO's have been signed.

https://www.youtube.com/watch?v=HmJKrhWucC0

Sun, 08/24/2014 - 18:19 | 5138215 ebworthen
ebworthen's picture

I'd bet Sears Holdings is at or near the top of the list.

Talk about driving a company into the ground...

Sun, 08/24/2014 - 18:31 | 5138247 Atomizer
Atomizer's picture

The DTCC has a blue light special running in isle #3. Hurry up while debt collateralized inventory lasts.  We need your COB by EOB.

/sarc

Sun, 08/24/2014 - 18:31 | 5138251 disabledvet
disabledvet's picture

"But the guy who actually has a billion dollars in net worth sees things differently."  Move along...

Sun, 08/24/2014 - 18:34 | 5138267 d edwards
d edwards's picture

Proof positive of the saying "a fool never learns."

Sun, 08/24/2014 - 18:33 | 5138262 Dr. Venkman
Dr. Venkman's picture

Corporate Bankruptcies are down year after year due to the easy money. This shit will explode once rates creep up. Of course, with the popularity of "structured dismissals" (and the acceptance of such by the DE and SDNY bankruptcy bench) there will be even more losers this time around.

Reason No. 892 why rates cannot ever go back up.

Sun, 08/24/2014 - 18:33 | 5138264 Dame Ednas Possum
Dame Ednas Possum's picture

What's the record height for a stack of cards?

Previous record must be long passed.

Keep stacking that phyzzz...

Sun, 08/24/2014 - 18:45 | 5138303 Fuku Ben
Fuku Ben's picture

When there are seemingly endless bailouts propping everything up is it really junk?

It's only junk when they finally pull out the magick carpet from underneath and let everyone fall into the bottomless pit.

Sun, 08/24/2014 - 18:47 | 5138306 Atomizer
Atomizer's picture

Just keep buying paper backed financial instruments on 30% recycled pulp paper. Save the environment and get ass fucked on debasing value of investment. Only Wall Street could pull this off in verbatim. 

Taxpayer open checkbook cures Government robbery. 

Sun, 08/24/2014 - 19:20 | 5138414 Ban KKiller
Ban KKiller's picture

But I need higher yield...any product, any place, any time. Sub-prime to the rescue. What rating do you need? What do you need the servicing to show? What numbers would you like in the books? None of this applies if MUPPETS are selling this shit though!

Sun, 08/24/2014 - 20:08 | 5138550 Catullus
Catullus's picture

Even warren Buffett admitted the juniors he bought on a TXU were the worst decision he's ever made.

Sun, 08/24/2014 - 20:31 | 5138611 SemperFudge
SemperFudge's picture

There's a new "something in existence poses more of a risk than subprime mortgages did in 2007-2008" headline every day now. Weren't subprime car loans the worst thing ever like just 3 days ago?

Sun, 08/24/2014 - 21:22 | 5138772 andrewp111
andrewp111's picture

This crap can just keep on humming along until the next oil shock hits. It will then collapse so fast that all these HY and equity investors will be in total shock. It could fall so fast they won't even have time to panic.

Sun, 08/24/2014 - 22:50 | 5139051 Richard Head
Richard Head's picture

What is the problem here? 2nd lien is a helluva lot better than UNSECURED CORPORATE DEBT.

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