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Who Will Suffer From A Leveraged Credit Shakeout?
Submitted by Charlie Hennemann via CFA Institute blog,
Of all the noteworthy moments from the 2014 CFA Institute Fixed-Income Management Conference, the bombshell may have been the default call from Martin S. Fridson, CFA.
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 assured the audience.
High-yield bonds, typically issued with credit ratings at the bottom of the scale, tend to suffer default surges during troughs in the credit cycle. The first high-yield default surge occurred from 1989 to 1992, and encompassed the collapse of Drexel Burnham Lambert. The second surge ran from 1999 to 2003, following the bursting of the dot-com bubble, and the third happened in the midst of the global financial crisis, from 2008 to 2009.
Fridson suggests the next default surge will be larger than the last three combined. Each surge saw an average annual high-yield default rate above 7% (which, if extended over a multi-year period, can add up to real money).
Fridson currently projects that 1,155 issuers will default in the next wave. Over a four-year period that easily surpasses the 644 defaults in 1999–2003, the largest of the three prior default surges.
Fridson: Distressed managers will have "plenty to do" in next cycle; predicts a cumulative HY default rate of 33% in 2016-19. #CFAFI
— Charlie Henneman CFA (@CHenneman) October 16, 2014
For context, Fridson points to the last default surge of 2008–2009: It lasted only two years, and the market swung from a record number of defaults in 2008 to a below-average number in 2009, something Fridson “would have said was impossible.” The reason, of course, was that interventionist policies did as intended in the wake of the financial crisis, cutting the credit cycle short and giving new life to many issuers that were staring default in the face. In the absence of a strong cyclical recovery, this may only have delayed the inevitable.
Fridson noted that since 2010, the high-yield market has seen deterioration in the credit-ratings mix even as it has grown at a compound annual growth rate exceeding 10%, fueled in part by European issuers accessing the high-yield markets in lieu of bank credit, which has been harder to get thanks to more conservative bank capital requirements.
One key assumption behind Fridson’s forecast is that the Fed ends its program of quantitative easing (QE) and allows interest rates to rise. QE may have ended, but Fed guidance calls for interest rates to remain low for a “considerable time.” Fridson was asked about QE and the persistence of low rates during Q&A after his presentation, and the answer left the audience murmuring.
“If we’re in this Fed rescue mode [in 2016–2019], then I think we’re in a lot of trouble. Very serious trouble.”
The final presentation at the Fixed-Income Management Conference was from Paul Travers, a manager of bank loans and collateralized loan obligations (CLOs) at Onex Credit Partners. Travers was quick to offer his thoughts about Fridson’s forecast, which would have a profound impact on the bank loan market if it comes to pass.
“I hope he’s wrong,” Travers exclaimed, noting that high-yield issuers are often also issuers of syndicated loans. “I don’t know if I can live through another four-year default wave.”
In a typical default situation, the holders of senior-secured bank debt would be expected to have much better recoveries than holders of the same issuer’s high-yield bonds, because bank loans have higher priority in the company’s capital structure. But investors in loans may not do as well in the next credit trough as they have in the past, as leverage multiples in the loan market have steadily climbed since 2011.
Unlike fixed-rate high-yield bonds, leveraged loans typically offer floating rates indexed off of Libor, usually resetting monthly, which provides some protection for investors against the prospect of a rising interest rate environment. Travers considers the current credit environment “relatively benign,” and said the current low-rate, low-growth environment is the “sweet spot” for the leveraged loan market — positive growth that isn’t rapid enough to threaten a rate increase. Under these conditions, the S&P/LSTA Leveraged Loan Index par amount outstanding increased to $768 billion in July of this year, adding $76 billion in the first half of 2014.
During his presentation, Travers noted that “Covenant Lite” loans now exceed 50% of the S&P/LSTA Leveraged Loan Index. According to Travers, fewer loan covenants wouldn’t necessarily lead to a higher incidence of defaults, since loan holders in most instances would be inclined to waive covenants rather than force an issuer into default. But over time, the lack of tight covenants could allow cash to flow out of the company, resulting in lower loan recoveries for investors in the event of default.
Of more immediate concern to Travers was the impact of retail fund flows on the leveraged loan market, which had seen 14 consecutive weeks of negative flows at the time of the conference after a long period of inflows. A fairly recent phenomenon in the leveraged-credit market, these retail flows from large loan managers — forced to buy and sell large blocks of loans to put cash to work or meet fund redemptions — contribute to volatility.
In addition to the underlying loan market’s volatility, Travers suggested the CLO market was experiencing volatility itself as a result of just-announced risk retention provisions under section 941 of Dodd–Frank, which would require managers of CLOs to own at least 5% of the risk in their portfolios. Anticipation of this rule was a contributing factor in the rush of CLO issuance in 2014, which equaled 187 deals at the time of the conference.
While the risk-retention requirement isn’t expected to kick in immediately, Travers suggested that going forward, investors should determine whether CLO managers have the capital to comply with this new requirement as part of their due diligence process.
Fridson and Travers approached the leveraged credit market from different perspectives, but their talks suggested that the placid environment encouraged by low interest rates and accommodative credit won’t persist. The next credit cycle will pose some serious challenges for leveraged-credit investors, regardless of their place in the capital structure.
Under the circumstances, the retail component of leveraged credit investments — absent from prior default surges — is probably not a positive development.
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Fucking oligarch fascist zionist cocksucking illuminati fuckfaces. My apologies, i've been drinking.
lol......
tequila, rum, or moonshine ?
Yes.
Just pulled the trigger on a MB and about to start drinking...heavily.
DON'T JUMP!!!
Leaping is more graceful...
And now we have an excuse for the next QE......
"Fucking oligarch fascist zionist cocksucking illuminati fuckfaces."
The FOFZiCoIFFs?!
An American, not US subject.
"You know it's bad when you need a shot of beer and a mug of whiskey."
Zerohedgers should note that anyone who mentions zionists and jews is instantly discredited in my mind. Why?
Math. That's why.
There simply are not many of them as a percentage. And their reproduction rates are in line with reason.
If you want to complain about someone talk about who is consuming and leading the "need" of all the governmental credit creation. The numbers speak for themselves on that account and Mr EBT does the talking.
what's worse is now we have to wade through all the puff pieces in the news about how what Japan is doing is for the good of all because DEFLATION BAD / INFLATION GOOD like I just read on SFGate... along with the usual programming about how 2% inflation is "just right"
grrrrrrr... now I know why they don't teach things like the rule of 72 etc. in school anymore, because anyone who could do that math would be heading for the barn to get the pitchforks out
If contracts were deflation indexed, then deflation wouldn't matter ... but contract/wage inflexibility will mean you lose output in deflation.
Me too
Of more immediate concern to Travers was the impact of retail fund flows on the leveraged loan market, which had seen 14 consecutive weeks of negative flows at the time of the conference after a long period of inflows. A fairly recent phenomenon in the leveraged-credit market, these retail flows from large loan managers — forced to buy and sell large blocks of loans to put cash to work or meet fund redemptions — contribute to volatility.
well....
it looks like 2007/08 will be multiplied many times.... and perhaps the final event before the great crash.... time to keep powder dry.... ready to buy assets at bargains.... (maybe)
patience is golden....
then again.....
The men that American people admire most extravagantly are the most daring liars; the men they detest the most violently are those who try to tell them the truth.
H.L. Mencken
The next credit cycle will...
lolololololololololol!!
I think he meant QE cycle...
zactly.
as if TPTB will allow another cycle. We're playing musical chairs to the weimar national anthem now. Japans descent into hyperinflation will not pull the others up - they will all still follow. The oligarchy are to be saved at all costs. only revolution - and not recession, depression or inflation - will alter that priority.
What do you know...bailouts of corrupt institutions, no jail, no reforms, FED backed bubble pumping leading to more debt and calls on margin bets at the casino...and guess who will get the bill?
The taxpayer of course! Slammed 401K's/IRA's/Pensions and more layoffs and mortgage defaults. Banks saved, regular folks raped. Lather, rinse, repeat. Start the hangings.
Again...just kill it with stupendous amounts of cash.
Forget reinvesting the dividends...stick it in the back, stuff it in your mattress, bury it in your walls. That is DEBT your holding and demand for dollars is ALWAYS infinity.
If you can compound PRINCIPLE you are a rich man indeed. A great example is life insurance. "Yes, you can borrow against that." Great way to structure "hereditary business issues" as well.
Still...nothing beats an oil well. "Go long the products that use it." Number one is the clothing industry. number two are banks and the debt issuance business.
We've gotten a sell off in junk already. With this much liquidity sloshing around (don't even get me started on natural gas) you have to be very careful about getting excited over sell offs meaning "the bubble has finally burst."
With metals prices having crashed that dollar could positively soar here. "There are no shortages of shipping ports in da USA." Once you throw in the Mississippi, Ohio and Columbia Rivers and simply put you can move everything in bulk. Coal, iron ore, cement...you name it. Of course this is fresh water. For open ocean "Chinese Class" you'll need huge dry docks. That's Portland, New Orleans, Philadelphia and I think Houston. Also Maine and Connecticut.
Obviously the biggest in the World are in Norfolk.
disabledvet, you speak the truth... the USA has resources and infrastructure in spades, much as the rest of the world thinks otherwise... couple this with the North American Combine *cough* I mean NAFTA, plus logistics capabilities that the rest of the world would dearly love to have, and you have a continental economy that's going to be super tough to bring down in a currency war... or any war, for that matter
and you're absolutely correct, of all the ports & docks in the world, the only one that truly matters is Naval Station Norfolk... you can also add Pearl Harbor-Hickam to that list
biggest commercial ports by tonnage in the US are Port of South Louisiana and Port of Houston, respectively... these are the only ones that I would classify as "China / Singapore" class
not Mad Max.
You need fuel for Mad Max. Scenario will be more Walking Dead than Mad Max.
possibly.
Who will suffer? The Bottom 99.999% as always.
FieldingMellish Who will suffer? The Bottom 99.999% as always.
----
Finally, someone with a clue. up arrow
People have progressed enough. It is long over due that money should be eliminated. It is also arguable that money should never have been used to advance civilization because of the inevitable end it portends.. How many crashed Koch brother spaceships do people need? Like nuclear power, whose brilliant idea was that. Anyhow the physical advancements have far outpaced human evolution and long since failed to address the human condition at a rate equal to population growth. I'm embarrassed at this point in planet earth's history to admit my heritage to any of the Q99X2 that I meet. When they say, "you seem to have an earthly dialect" I say, my ancestors escaped from that forsaken bankster infested hell-hole over 30,000 years ago. The scumbag banksters were only ruining the lives of buffalo at that time.
wait, are you the drunk dude?
You are aware that a gold currency would have eliminated money as a natural end result? The logical end game to money in an economy with growing productivity is DEFLATION...finite money supply being stretched ever thinner and thinner until it becomes more trouble than it is worth. Finally, eliminated in favor of the next step up the evolutionary chain.
WTF are you on about? Koch spaceships, brother keep the shrooms down to 1 gram or less and peyote fugggedaboutitt
Dick Branson spaceships?
That would be Sir Dick Branson, virgin.
http://www.bbc.com/news/world-us-canada-29857182
When leverage is being leveraged and the S&P keeps magically rising beyond any reasonable time frame, and with almost no participation, it's time to dress for a s@#t storm.
I haven't had anything to drink... Every assclown douchewad hedge fund, ass licking pension fund manager comes to mind.
I haven't had anything to drink...
maybe you ought to start..... -g
O¿O
Yeah right! Which category do you fit in Junior?
Drifting off the financial cliff?
That's alright though. I'm sure you'll get your 2 and 20.
"Who Will Suffer From A Leveraged Credit Shakeout?"
The Goy.
A non "return" able American, not US subject.
I say shitgums for all concerned! Who can top the guy who nailed gunned himself to death? Fucking awesome!
Shitgums, nailguns, tall buildings and bridges.
"Banana in the tail pipe.
I mean who would ever fall for the banana in the tail pipe?"
The potato salesman.
When individuals like you and I stop borrowing money for cars and houses then and only maybe then should we start criticising governments for borrowing. It's human nature to want everything now.
What a strange world it would be if there was no credit, that everything had to be bought with saved money. Wonder if it would work? And don't tell me that without a loan from a bank you couldn't buy a house, I say, so what, OK, you can't buy a house. If you can save the money or combine resources with friends and family then you can buy the house.
Well, anyway, we live is perilous times beyond which I seriously dount we are prepared for.
youd just save then buy the land and build the house yourself.
folks from cushy western countries dont think this way because we tend to specialise. If yer a musician or a beaurocrat in the West, you cant build houses for shit. You take the average guy from the middle east or africa, they can build their house themselves no matter what vocation they have. Might not be to mcmansion standards, but then its about economic feasibility - which mcmansions arent built for
Careful with the term "human nature"...It is a not a constant, but a variable that is easily (in most cases) manipulated to the detriment of the manipulatee.
But we elect our leaders to manage the financial affairs of our nation wisely and responsibly. Because of their foolishness the entire house of cards is on the verge of collapse. It appears that few realize that complete national ruin is fast approaching. Read Revelation 18, a chapter that proves that Bible is the word of God. Nuclear destruction predicted 2,000 years a go. Only by nuclear bombs could an entire civilization be destroyed ("utterly burnt with fire") in the space of only one hour. Does anyone really believe that the heavenly watchers have not been keeping an account of the millions of innocents our nation's policies have sent to an early death over the decades, the carnage and suffering we have inflicted for oil and financial gain? It's nothing short of murder on a massive scale. Every nation has a cup of iniquity. The United States is filling its cup to the brim. As Thomas Jefferson said, "I tremble for my country when I consider that God is just, that his justice will not slumber forever."
18:7 How much she hath glorified herself, and lived deliciously, so much torment and sorrow give her: for she saith in her heart, I sit a queen, and am no widow, and shall see no sorrow.
18:8 Therefore shall her plagues come in one day, death, and mourning, and famine; and she shall be utterly burned with fire: for strong is the Lord God who judgeth her.
18:9 And the kings of the earth, who have committed fornication and lived deliciously with her, shall bewail her, and lament for her, when they shall see the smoke of her burning,
18:11 And the merchants of the earth shall weep and mourn over her; for no man buyeth their merchandise any more:
18:14 And the fruits that thy soul lusted after are departed from thee, and all things which were dainty and goodly are departed from thee, and thou shalt find them no more at all.
18:15 The merchants of these things, which were made rich by her, shall stand afar off for the fear of her torment, weeping and wailing,
18:17 For in one hour so great riches is come to nought. And every shipmaster, and all the company in ships, and sailors, and as many as trade by sea, stood afar off,
18:18 And cried when they saw the smoke of her burning, saying, What city is like unto this great city!
18:19 And they cast dust on their heads, and cried, weeping and wailing, saying, Alas, alas, that great city, wherein were made rich all that had ships in the sea by reason of her costliness! for in one hour is she made desolate.
Money was created by the market because there was a need for it. Money is half of every market transaction. Gold was selected as the best money because it contains within it the value required to produce it; this provides the basis for its ability to hold its value over time: it cannot be easily counterfeited. Money allows infinite division of labor, which allows infinite creativity across all of civilization. Money will not be eliminated ever; there has to be a way to keep score, and the scorekeeper must be honest. Every effort by man to improve on God's money has failed, because men are easily corrupted. Deflation of the money supply is not a problem, especially now that we have computers: suitable exchange records could be achieved using 100% gold backed credits. The price of gold could be adjusted periodically by vote or designated committee. Since everyone who held credits (in a computerized bank account) would benefit by the same exact percentage, no one benefits from such deflation. Since no human organization has shown the necessary honesty needed to make the system work, we do not have such a perfect money system in place yet. Perhaps during the Chinese dominance era we will see such a system evolve; the Chinese know the hazards of fiat, and they want none of it.
Fishhawk
"Because gold it honest money, it is disliked by dishonest men." Ron Paul
@BringontheAsteroid: no one said that an honest money system would preclude the use of credit. But credit is borrowing from the future, and it needs to be tempered by realism. Banks used to actually loan money to borrowers from the funds of savers. That system was called the 100% reserve plan, and banks were careful about loaning money because they were concerned about the borrowers ability to pay it back. In our current fraudulent fiat system banks loan money out of nothing; every 'loan' creates new debt, expanding the money supply without bound, with no concern about whether the 'loan' will ever be paid back. The bank does not care a whit, since they have no skin in the game: the bank loaned the borrower his own credit, and charged him for the privilege. If the borrower goes bankrupt, the bank seizes the real asset involved. Over time, the banks will own the world using this system. Fiat is fraud and theft, designed by the bankers and supported by politicians.
Fishhawk
I try to warn my friends of the impending crisis which faces the US and of course the response is that I'm crazy... Even in the face of proof, they are in denial...
I showed a couple friends this link today about the continued de-dollarization movement...
http://www.zerohedge.com/news/2014-10-30/dollar-decline-continues-china-...
Of course they bleated that the USD will be the world's reserve currency for the rest of their lives and that it would take a collapse to unseat it... I was labled crazy, yet again, for saying that the USD would be lucky to hold this position until the end of this decade...
I am not my brothers keeper, so I wish them well on their path... I'm bugging out as I have learned to never step in front of a moving train...
You cannot separate fools from their foolishness, even though you grind them like grain with mortar and pestle - Proverbs 27:22
The fiscal insanity and arrogance that piles mountains of new debt on our backs every hour certainly bears this out.
Most people are blind to the events that will soon come about. A great deal of the shadow banking world falls into and overlaps into the grey world of derivatives. There is no single commonly adopted definition of derivative or derivative contract in the European Union. This plays havoc with what and when reporting rules apply. It also highlights divisions in how national regulators view reporting rules for the $693 trillion over-the-counter derivatives market.
Remember this is only part of a much larger market that includes hundreds of trillions of dollars in non-reported agreements and private contracts. Everyone paying attention knows that the size of the derivatives market is 20 times larger than the global economy, the article below explores some of its ins and outs.
http://brucewilds.blogspot.com/2014/03/derivatives-house-of-cards.html
It's all just fun and games...
Until someone can't pay.
The problem is there is no better reserve currency candidate available.
For all its sins the US Dollar is still the most stable environment in the world.
The Yen and the entire Japanese economy is now officially a joke.
The Chinese and Russians are communists and their philosophy always gets in the way of any real economic longevity, eventually they always implode... and take your investments.
So we have Germany and Great Britain as our reserve choice over the dollar... I think not.
A blackhole identified by the CFA guy in sunlight. As usual far behind the curve. Months ago, the yield chasing muppets have already provided the easy feeds.
This is documenting history not forecasts.
Politically popular companies will be saved from bk and a few unpopular companies will not. Popularity is proportional to political donations/support and degree of government support. Bondholders in companies that are politically unpopular will get wiped out and those in politically favored companies will lose a little less. Retail holders of leveraged debt will lose everything and the banks will be bailed out - as always. Rinse - repeat.
The first goal in achieving financial security is to take steps that insure capital preservation. One thing has become crystal clear over the last few decades and that is the economic landscape is constantly changing this means we really are no safer today than in the past. One day you can be a hero and the next day a goat.
One of my largest reasons for concern is I feel that many of the numbers being presented to us do not make rational sense, the "numbers don't work." The article below delves into how all of us will be vulnerable if the current financial system breaks down and has to be rebooted or restarted under new or drastically different set of rules.
http://brucewilds.blogspot.com/2014/11/capital-preservation-is-job-one.html
You can literally watch money disappear from the community in so many ways as this huge black hole of finance the CB's have created vacuums up everything. It is now feeding on itself as demand is falling.
This is what happens when Tim Cook comes out