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An Unlikely Sector Leads the Way in Surge of Corporate Leveraged Loan Defaults

oil gas companies

From Birch Gold Group

The economic effects of the COVID-19 pandemic and recent Fed monetary policy continue to reveal themselves.

The latest “reveal” that’s taking center stage is risky corporate leveraged loans, with defaults soaring to their highest levels since 2010 by issuer count, and since 2015 by rate.

report by S&P Global Intelligence breaks everything down, starting with a summary:

U.S. loan defaults continued to rise in July, surpassing 4% by issuer count for the first time since 2010, after five constituents of the S&P/LSTA Leveraged Loan Index tripped defaults on $7.7 billion of term loans.

You can see the billions in defaults by year in the chart below, and how the U.S. hasn’t seen an amount even close since 2009 (with four months still remaining in 2020):

us leveraged loan defaulted amount

“With economic fallout from the coronavirus pandemic playing an increasing role, default volume over the last 12 months, at $46.35 billion, outpaces the same period of 2019 by 233%,” according to the same report.

Even more sobering than this astonishing surge, it looks like a critical sector of the economy that shouldn’t be defaulting on leveraged loans is the sector that’s contributing the most defaults…

Oil and Gas Companies Reveal How Fragile the Situation Is

It appears things wouldn’t be “so” bad if oil and gas companies weren’t defaulting by more than 30% of their total loan amount. You can see their “contribution” to this dire situation reflected in the chart below:

us leveraged loan default rate by amount

You can also see how oil and gas leveraged loan defaults could also have played a role in the dramatic Dow crash at the end of 2018 in the same chart above.

The S&P Global report notes that some examples of the energy sector carnage include (but are by no means limited to):

…click on the above link to read the rest of the article…

 

Satyajit Das: The CDO Bomb That Blew Up In 2008? There Is A New One

Satyajit Das: The CDO Bomb That Blew Up In 2008? There Is A New One

In recent months, with the investor spotlight increasingly falling on the “leveraged loan problem”, or the fact that there are now more leveraged loans outstanding – most of them offering virtually no covenant protection to investors and effectively stripping them of their “secured” position in the capitalization waterfall thus making them pari passu with high yield debt – than junk bonds, there has been a resurgence of discussions whether CLOs are the next “ticking timebomb”, and whether Collateralized Loan Obligations which have emerged as the primary source of demand for new loan issuance, will be the new CDOs and catalyze a systemic crash.

In an attempt to short-circuit such concerns, two weeks ago Barclays published a “CLO mythbuster” piece, in which it first noted that since 2008, Bloomberg, the Financial Times and even Hollywood have provided the general public with myriad causes of the Great Financial Crisis (GFC), “rarely failing to include a layman’s introduction to CDOs and how they played a major role”, and noting that “more recently, this conversation has grown to include comparisons to today’s CLO and leveraged loan markets, with premonitions of another GFC brewing just a decade after the last with CLOs acting as an accelerant.”

But first, this is Barclays defines a CDO in general, and a CLO in particular:

The term CDO actually covers an array of structured vehicles backed by debt, whether that debt is leveraged loans (CLOs), high-yield bonds (CBOs) or even other structured products (CDO-squared). So, while CDO subsets may have somewhat comparable structures (an SPV issues debt tranches, AAA through equity, and buys assets), the performance of the underlying assets and the ability for the vehicles’ liabilities to match the cash flows generated by those assets have proved vital for the future performance prospects of structured products.

 …click on the above link to read the rest of the article…

Debt is back but this time its corporate

Debt is back but this time its corporate

On Wednesday Feb 7th 2007 HSBC issued a profit warning.  It was the first in its 142 year history. The bank told its share holders it would have to take an unprecedented charge of $10.5 billion because one of its units, its sub prime lender, was in deep trouble. And so began the sub prime crisis.

Today GE issued a profit warning and cut its dividend to share holders from 12 cents to 1 cent. It is only the third time since the Great Depression that GE has reduced its dividend in this way. It told its share holders it would be taking a $22 Billion charge because one of its units, its power unit, is in deep trouble. GE has about $116 billion in debt.

In 2007 the banks had flooded the global market with sub-prime loans. The banks were also holding many of those same loans themselves or had transferred them to Special Purpose Vehicles (SPVs) they had set up, staffed and lent money to.

Today it is not the banking world which stands at the centre of the storm but the corporate world. In the last years they have flooded the market with junk rated bonds. At the same time they are also burdened with high yielding, leveraged and covenant- lite loans. Taken together they are about $2.4 Trillion of debt.

2007 sub prime loans. 2018 corporate junk bonds and leveraged loans. 2007 banks and SPVs funded by the banks. 2018?

Where is this sub-prime corporate debt sitting today?

 

Nearly half sits in Insurance Companies and Pension funds.

Given the close ties between insurance and pensions this is not a happy picture.

…click on the above link to read the rest of the article…

Leveraged Loan Demand Is Off The Charts As Dangers Mount

Ten years after the crisis, demands for leveraged loan offerings is once again off the charts. Portfolio managers who are seeking rising yields as the Federal Reserve hikes rates have shown unprecedented demand for recent deals, despite repeated warnings that they may be buying “at the wrong time.”

Leveraged loans are a type of debt that is offered to an entity that may already have significant amounts of leverage or a poor credit history. As rates move higher, the loans – whose interest rates reference such floating instruments as Libor or Prime – pay out more. As a result, as the Fed tightens the money supply, defaults tend to increase as the interest expenses rise and as the overall cost of capital increases.

Gershon Distenfeld, co-head of fixed income at AllianceBernstein LP and a longtime “skeptic of bank loans” told Bloomberg that a good way to gauge the risk in the loan market is to look at returns when loans price too high. Currently, the average outstanding loan is priced at about 98.5 cents on the dollar. According to Distenfeld’s research of market prices between 1992 and 2018, when priced at this level, annual returns are about 2.8% for the following two years – lagging both behind 5 year treasuries and high yield bonds. And yet investors are piling in, hoping for even more generous payments, and oblivious of whether the underlying credit will be viable in a higher interest rate environment.

Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC kept it simpler: “It’s not a good time to be buying bank loans,” he stated. He also noted something we have demonstrated on numerous prior occasions: lender protections are worse than usual and there’s a smaller pool of creditors to absorb losses, and as covenant protection has never been weaker.

…click on the above link to read the rest of the article…

Treasury Warns Congress (and Investors): This Financial Creature Could Sink the System | Wolf Street

Treasury Warns Congress (and Investors): This Financial Creature Could Sink the System | Wolf Street.

Office of Financial Research slams Leveraged Loans

In its 2014 Annual Report to Congress, the US Treasury’s Office of Financial Research, which serves the Financial Stability Oversight Council, analyzed for our Representatives the “potential threats” to the US financial house of cards. Among the biggest concerns was a financial creature that has boomed in recent years. The Fed, FDIC, and OCC have warned banks about it since March 2013. But they’re just too juicy: “leveraged loans.”

Leveraged loans are issued by junk-rated corporations already burdened by a large load of debt. Banks can retain these loans on their balance sheets or sell them. They can repackage them into synthetic securities called Collateralized Loan Obligations (CLOs) before they sell them. They have “Financial Crisis” stamped all over them.

So the 160-page report laments:

The leveraged lending market provides a test case of the current approach to cyclical excesses. The response to these issues has been led by bank regulators, who regulate the largest institutions that originate leveraged loans, often for sale to asset managers through various instruments. Despite stronger supervisory guidance and other actions, excesses in this market show little evidence of easing.

How did we get here?

…click on the above link to read the rest of the article…

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