"Winter Is Coming" For Leveraged Companies 

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by Tyler Durden
Friday, Dec 08, 2023 - 05:45 PM

Earlier in the year, as regional banks faced a domino effect of failures, Bank of America strategist Michael Hartnett pointed out that every Fed tightening cycle has historically resulted in a crisis.

Given that the Federal Reserve hasn't allowed a real credit cycle since the early 2000s, prolonged monetary tightening suggests that "winter is coming" for leveraged companies. 

"The whole market and companies have been living in this la la land, this fake world of wealth of quantitative easing where you can borrow at 1% or 2%, you can buy anything, you can make lots of mistakes and you're not going to get called out," said Paul Horvath, chief executive officer at investment firm Orchard Global. 

Horvath, speaking at the Milken Institute's Middle East and Africa Summit in Abu Dhabi this week, was quoted by Bloomberg. He warned: "Winter is coming, and I don't think people have enough parkas."

The asset manager head said financial markets are holding up well so far, given the high rates. He noted corporates are levered up due to private equity firms buying up companies with cheap money, adding a global financial crisis might not be in the cards - but expects there will still be stress. 

Bloomberg pointed out there were record levels of dealmaking during the pandemic era of cheap money. This led to a surge in private equity buyouts, backed by leveraged finance and the debt load placed on the target company. A large amount of that debt for junk-rated firms is coming due as large maturity walls approach. 

Also speaking at the event was SLR Capital Partners co-founder Michael Gross, who said there is no easy solution for companies needing to refinance this debt. 

"It's going to take more than public markets coming back," Gross said, adding, "It's going to probably require private equity sponsors to find unique solutions like putting in more equity or finding preferred investors to step into the capital structures."

Gross said managing portfolio companies with outdated debt structures will also face challenges for private credit funds.

He explained that funds were structured in a world of "perfection" based on an era of low interest rates, but that has all changed. 

A higher for the longer environment with mounting macroeconomic headwinds only means over-leveraged firms are increasingly falling into distressed

The impact of this tightening cycle could be worse than the Great Recession - unless the Fed reverses course. 

Rate traders are already pricing more than 100bps of rate cuts for 2024. 

Meanwhile, Anne Walsh, chief investment officer of Guggenheim Partners Investment Management, said the US economy "hasn't had a real corporate credit cycle since the early 2000s," indicating a "purge is about to happen."