Wolf
Richter www.testosteronepit.com www.amazon.com/author/wolfrichter
It has been a feeding frenzy for junk debt.
Yield-desperate investors, driven to near insanity by the Fed’s
strenuous interest-rate repression, are holding their noses and
closing their eyes, and they’re bending down deep into the barrel
and scrape up even the crappiest and riskiest paper just to get that
little extra yield.
Last
year, highly leveraged companies issued $1.1 trillion in junk-rated
loans. It’s a white-hot market. Leveraged-loan mutual funds –
dolled up in conservative-sounding names and nice charts to seduce
retail investors – gorge on these loans. They saw 95 weeks in a row
of inflows, week after week, without fail, adding over $70 billion to
their heft, as Bloombergreported,
and only the sky seemed to be the limit. But suddenly, that endless
flow of money reversed.
“It’s going to be a disaster on the way
out,” Mirko Mikelic, who helps manage $7 billion in assets at
ClearArc Capital, told Bloomberg. “On the way in, there’s
insatiable demand….”
Private equity firms have been ruthlessly
taking advantage of that “insatiable demand.” And they have a
special self-serving trick up their sleeve: Their junk-rated
overleveraged portfolio companies issue new loans, but instead of
using the funds for expansion projects or other productive uses, they
hand them out through the back door as special dividends. It’s one
of the simplest ways PE firms use to strip cash out of their
portfolio companies. It loads even more debt on the already highly
leveraged portfolio company without adding productive capacity. And
those who end up holding this debt – for example, the mutual fund
in your portfolio – have a good chance of losing it all.
“It’s
kind of like an epidemic,” explained Martin Fridson, a money
manager at Lehmann, Livian, Fridson Advisors LLC, in an interview
with Bloomberg.
“Once an investment banker sees that, he’s going to go to his
clients and say, ‘Here’s a window of opportunity, you can take a
dividend and get away with it.’”
And
they’ve been getting away with it. Default rates on junk debt
hovered at 1.7% in the first quarter, a near record low. But
that’s always the
case when liquidity sloshes through the system and years of interest
rate repression turns yield investors into brain-dead zombies, always
willing to replace troubled debt with new money. But the historical
average is 4.5%, and when things tighten up, as they did during the
financial crisis, default rates jump into the double digits
[read.... Biggest
Credit Bubble in History Flashes Warning: ‘Seek Cover’].
They’re all doing it. Junk-rated mobile-phone
insurer Asurion finagled a $1.7 billion loan in March. But instead of
doing something productive with the funds to generate cash flow to
service the loan, it blew the money out the back door as a special
dividend which it owners – PE firms Madison Dearborn Partners,
Providence Equity Partners, and Welsh Carson, Anderson & Stowe –
pocketed with gusto.
BMC software borrowed $750 million via one of
the riskiest forms of debt, payment-in-kind (PIK) notes, where, if
push comes to shove, BMC can chose to pay interest not with cash but
with more of the same debt. The amount it owes gets larger, as its
chances of survival shrivel. Instead of defaulting, the company will
simply hand the lender more paper that’s increasingly worthless.
BMC promptly forwarded the $750 million to its owners, a group of PE
firms let by Bain Capital that had acquired BMC only seven months
earlier.
Time
is of the essence. Platinum Equity, which had acquired Volvo’s
rental car division, waited only
a week after
closing the deal before sucking $262 million out that the company had
obtained by issuing PIK debt.
So far this year, these already overleveraged
companies have issued nearly $21 billion in junk-rated debt for the
purpose of paying special dividends to the PE firms that own them –
the most since the bubble of 2007, before it all blew up
spectacularly. Of that, $3.5 billion were these reeking PIK notes.
When a default occurs, the PE firms have the cash, and the lenders
get stuck with largely worthless paper.
That’s what invariably happens when the Fed’s
interest rate repression pushes investors out toward the thin end of
the risk branch. During normal times, no sane lender would go along
with this without demanding a confiscatory yield. The door would be
closed to these sorts of glaring wealth-transfer shenanigans. But
these are not normal times. This is the greatest credit bubble in
history.
Among the most insatiable buyers of this stuff:
leveraged-loan mutual funds, and by extension, retail investors. But
now, they’re getting cold feet, apparently, and for the first time,
after 95 weeks in a row of inflows, they yanked money out, Bloomberg
reported. Not a panic just yet, but the flow has reversed. In the
week ended April 16, they drained $276 million out of these mutual
funds.
And
these funds are starting to bleed. The LS&P/LSTA
Leveraged Loan 100 Index,
which sports a 5-year annual return of 10.5%, dipped into the red for
April and might book its first monthly loss since the taper-tantrum
turmoil last summer.
Mutual funds that hold leveraged loans are
fearsome products. They entice investors with a little extra yield,
but still less than an FDIC insured one-year CD used to pay in the
pre-crisis days. That’s how far the Fed has pushed it. But these
loans are even less liquid than corporate bonds. Unlike bonds or
stocks, they’re not regulated. They’re traded the old-fashioned
cumbersome way, via email or even the phone, involving complex
paperwork that may take weeks to complete. It’s not easy to
transfer a loan. And when belatedly spooked investors start selling
these mutual funds, fund managers are forced to dump loans into a
market where liquidity just evaporates without notice. Prices plunge
on the sales that do go through – and those who get out first,
bleed the least.
“We
all feel like we’re at the top of the cycle, and everyone’s
skating on new ice,” explained Nick Beim about a parallel and
equally treacherous aspect of the bubble that everyone knows is going
to deflate someday with a terrific hiss. He is a partner at
venture-capital firm Venrock, and the startup scene has come
unhinged, with 33 startups in the US alone having valuations of $1
billion or more. Dropbox crowns the list at $10 billion. A lot of
moolah for a small money-losing outfit. But turmoil and losses and
whiffs of reeking reality have suddenly replaced blue-sky exuberance.
Read…. IPO
Craze Peaks, Investors Scurry Out of the Way, VCs Fret
No comments:
Post a Comment