“It’s very, very frustrating from the perspective that you don’t know how much more they know that they’re not telling you” – Standard & Poor’s Shannan Murphy about Millennium Health.
Millennium Health – biggest drug-testing lab in the US and biggest recipient of Medicare drug-testing payments, which account for one-third of its revenues – is Exhibit A of how a credit bubble allows companies and banks to put yield-desperate investors, blinded by a zero-interest-rate policy, through the wringer.
The San Diego-based company is owned by its executives and private-equity firm TA Associates. It issued a junk-rated loan of $1.775 billion due in 2021 that JPMorgan syndicated in April 2014. The pieces were eagerly bought up by institutional investors, among them Oppenheimer Funds, Fidelity Investments, and Franklin Resources. They’d stuff part of it into mutual funds owned by retail investors.
Millennium didn’t invest the loan proceeds in productive activities. Instead, $195 million was used to pay off debt that TA Associates held. And $1.297 billion was used to fund a special dividend to its owners.
These “leveraged loans,” issued by junk-rated over-leveraged companies, form an $800-billion market. They’re too risky for banks to keep on their books. So they sell them directly or as Collateralized Loan Obligations (CLOs) to institutional investors. The Fed has been fretting about leveraged loans for two years; they can sink banks that get stuck with them, as they did during the Financial Crisis.
Leveraged loans trade like securities. But the SEC, which regulates securities, considers them loans and doesn’t regulate them. No one regulates them. This gives issuers and banks a lot of leeway.
In addition, Millennium’s leveraged loan was “covenant-lite,” a common disease these days, with few of the protections that investors demand during saner times. ZIRP purposefully blinds investors to risks and turns their brains into Jell-O. And they do anything and give up anything just to get a little extra yield.
This April, the loan was still trading above par, and investors were happy. By June 17, it was trading at 45 cents on the dollar, S&P Capital IQ LCD reported at the time. By June 24, offers were down to 41 cents on the dollar. Investors had lost over 60%.
What the heck had happened?
A possibly debilitating fact Millennium and JP Morgan had known about for years but didn’t disclose in the loan materials or during the presentations in 2014 suddenly had become a story again in May: In a case that had been dragging on since November 2012, Millennium was nearing a $250 million settlement with federal regulators and the Department of Justice, in a case none of the investors had known about, to be settled with money Millennium didn’t have.
Bloomberg reported today of how that went down:
A year after JPMorgan pitched the loan, Millennium began drawing increased scrutiny from holders after posting copies of letters from the Centers for Medicare & Medicaid Services on its private lender website in April, the people said.
In them, the federal health-care agency threatened to revoke Millennium’s ability to charge Medicare and Medicaid because of the alleged billing irregularities, which included urine tests the company never performed, even for dead people.
In a private follow-up conference call on May 21 with some of the lenders, the company disclosed the settlement.
One problem: Millennium might not have enough money to pay for the settlement; it had $67 million in unrestricted cash at the end of March, Moody’s reported when it downgraded the company deeper into junk, with negative outlook. And given its current condition, it might not be able to borrow anymore.
The other problem: Millennium hired a debt restructuring firm. Now lenders get to contemplate the possibility of bankruptcy.
Oh, and another problem: according to Bloomberg, citing “people with knowledge of the disclosures,” Millennium told lenders that earnings, excluding some items, had plunged 31% to $68 million.
But lenders could have known about its legal problems. Just as JP Morgan knew. In November 2012, Reuters broke the story, U.S. Drug Testing Firm Probed for Alleged Fraud, Intimidation”:
A federal grand jury in Boston is investigating Millennium….
The company not only is under investigation by the Justice Department for allegations of health care fraud but also for intimidating former employees, one who was portrayed in a slideshow at a company meeting as a corpse in a body bag.
Two of the ex-employees, who had raised concerns about Millennium’s sales practices, also say they were followed for weeks by private investigators they believe were hired by the company.
You get the drift.
A month ago, the story transitioned from private to public via the Wall Street Journal, based on “four people familiar with the negotiations”:
The nation’s largest drug-testing laboratory, Millennium Health LLC, is negotiating a major settlement over allegations it billed the federal government for unnecessary tests, the latest sign of a crackdown on the fast-growing industry.
Settlement talks come as the federal Medicare agency is proposing broad changes to the way it pays for urine drug tests that could save taxpayers money and cut into drug testers’ revenue. Such tests can search for drugs including narcotic pain pills and illegal substances such as angel dust and club drugs like MDMA.
So it’s not just the settlement that it might not be able to pay for. Its revenue stream would also be hit.
And the loan collapsed entirely. S&P Capital IQ LCD at the time:
Sources attribute the continued secondary market weakness in part to a dearth of new buyers for the loan – the private nature of the discussions between the TA Associates-controlled company and its lender group is a disincentive for new market participants without access to confidential information to get involved.
Disappointing fourth-quarter and first-quarter results have also exacerbated secondary-market losses.
On July 1, LCD found that its “shadow default rate” had risen due to the “sudden emergence” of Millennium “among the walking wounded.” The trigger: Millennium had hired Lazard and law firm Hogan Lovells for potential negotiations with creditors to reduce its debt.
How did lenders step into it so blindly? Bloomberg reported today that JP Morgan, which knew of the federal investigation, “didn’t share that information … because Millennium said it wasn’t material, according to a person with direct knowledge of the matter.”
Yet nothing about the probe, such as its potential impact on Millennium’s finances, was included in the official document that JPMorgan used to market the loan, four people with direct knowledge of the matter said.
Two loan investors, who asked not to be identified because they weren’t authorized to speak publicly, also said neither JPMorgan nor Millennium mentioned the probe when the loan was pitched
JP Morgan could do so because it was a loan, not a security. And no one regulates trading in loans. Further:
Borrowers can limit who can access their financials, control the type of data they get, and even blacklist certain investors from ever buying the loan.
It’s not only the lack of disclosure that’s stung holders. Blacklists are a hallmark of the loan market, and Millennium stood out for compiling one that prohibited dozens of big-name funds from buying the loan through its maturity, according to people with knowledge of the matter.
The company also blocked would-be investors from getting their hands on its financial data for weeks as the loan plummeted, they said.
Thus, investors who wanted to dump this thing early on were stuck because there were no buyers, because buyers couldn’t get the information they needed, and so frustrated holders watched as their formerly high-yield investment plunged toward the realm of default.
Millennium’s blacklist includes distressed-debt buyers, or vulture funds, such as Appaloosa Management and Fortress Investment. It prevents them from jumping into the fray and advocating with their big megaphone for very inconvenient creditor rights.
A “majority” of these creditors, according to Bloomberg, are now exploring legal options, “including whether to declare a default.”
And Millennium’s owners who paid themselves a $1.3 billion dividend, among other goodies? Turns out, the “reach for yield” is one of the most efficient wealth transfer mechanisms known to mankind. They knew exactly how to use it, even while the company was under investigation, and they got their money out a year before the debilitating settlement.
The “reach for yield” has been topic of numerous Fed statements. It’s one of the unspoken reasons why the Fed is moving to raise rates. September is the hot date. Read…. Despite Wall Street Conniptions, Another Fed Dove Caves