“Leveraged Loan” Time Bomb Goes Off

“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

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  20 comments for ““Leveraged Loan” Time Bomb Goes Off

  1. hoop
    Jul 17, 2015 at 6:00 am

    This article confirms my reply on ‘’The Biggest Energy Crooks’’ from yday. Nothing to add. The military could not explain how they spend 2 trillion dollars. The European Commission have not past an audit of an independent audit bureau like KPMG or Deliote etc for more than 20 years or so. FIFA based in Switzerland seems to be corrupt to. Foreigners (Chinese) laundering money via your housing industry. Happens in London too. Bank of America laundering money for drugs cartels. The list goes on and on. It is the basic business model now in the western world. Our Southern brothers in this world are simply not so good in marketing and ‘’perception’’management of their fraud and corruption etc. Also the press like to report on them and not on their own northern brothers, so the sheep’s feels good at home and will not try to leave the sinking ship called the first world.

  2. Spencer
    Jul 17, 2015 at 7:20 am

    Is there an honest business left in the USA?

  3. Gee
    Jul 17, 2015 at 8:04 am

    Yup, a well-oiled (w/ banker lube) machine of institutionalized corruption. WASS

    • Vespa P200E
      Jul 17, 2015 at 2:07 pm

      Leverage is awesome when the asset price goes up BUT it’s your very money that burns 1st if asset price goes south and it really sucks when asset value goes below loan amount.

      That said banksters play different game where where profits are privatized and losses are “socialized” via bailouts like TARP and government taking over AIG so banksters are paid off paid for by taxpayers.

  4. NY Geezer
    Jul 17, 2015 at 8:27 am

    “The company … is under investigation by the Justice Department for allegations of health care fraud )and) … for intimidating former employees, one who was portrayed in a slideshow at a company meeting as a corpse in a body bag.”

    The Mafia provides the business model for the US business corporation in this case.

    Its a very sad state that we are in when Medicare and Medicaid laws and regulations are designed to allow such organizations to conduct their fraud based business model without any effective regulation thereby driving up the costs of health care for virtually nothing of value. There is almost no value in testing when so many tests are faked. This is not a small fraud. “Millennium Health – (is the) biggest drug-testing lab in the US and biggest recipient of Medicare drug-testing payments…”

    It should certainly be expected that this kind of management would not ignore the potential in the $800-billion junk bond market. The larger crimes are that such a market has been and continues to be unregulated and that so much taxpayer, pension, and fund money is wilfully poured into it to keep it going for so long. There are a lot of individual co-conspirators here who should be and never will be criminally prosecuted. The US model of only imposing civil and criminal fines on corporations penalizes only the shareholders not the criminal actors. The model’s corollary of also not prosecuting the criminal actors makes sense only when the entire system is corrupt.

  5. Paulo
    Jul 17, 2015 at 8:30 am

    re statement: “And $1.297 billion was used to fund a special dividend to its owners.

    This reminds me something about a restaurant I saw in the movie, “Goodfellas”.

    And then there was a fire.

    A crook is a crook is a crook.

  6. Petunia
    Jul 17, 2015 at 8:41 am

    The business model for every large American company is that they run on the money they raise on Wall St. Income and revenue are not entirely irrelevant, they contribute to the Potemkin Village mirage, that the business is a going concern. Take away the borrowed money and the vast majority would disappear.

    The reality is that real wealth was created at the bottom through hard work and savings, and Wall St. has stolen it under the guise of investing in America. Look at the results. Now managements steal the money outright from the banks and the customers. They are tired of pretending too.

    • LeftCoastIndependent
      Jul 17, 2015 at 9:50 am

      What you just said is what Mitt Romney and Bain Capital did hundreds of times. Read the article “Matt Taibbi/Rolling Stone/ The Real Mitt Romney”. It explains in detail how he leveraged companies, robbed pension funds to pay for it, stuffed his pocket with million dollar fees, and then bankrupted the companies. He left the employees without a job and without a pension. He is more than disgusting.

      • Petunia
        Jul 17, 2015 at 10:21 am

        I know all about Mitt, that’s why I voted third party, I wanted them to know I was unimpressed.

  7. hoop
    Jul 17, 2015 at 9:19 am

    Nice article, at show an example of what the shadow side of ZIRP/NIRP does to normal hardworking business man and workers in other countries. Low interest rates causing over investment china’s steel plants and consequently is killing business in India.

    http://gcaptain.com/is-this-the-end-for-south-asia-shipbreakers/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+Gcaptain+%28gCaptain.com%29#.VakOPvnjCSd

  8. Vespa P200E
    Jul 17, 2015 at 12:08 pm

    Bah humbug (literal meaning of fraud and not X-mas) – Just tip of an iceberg…

    Sounds like repeat of 2008 web of CDO/CDS mess is about to unwind but alas there is no government owned AIG to pay everyone off where profits are privatized and losses are “socialized”. And over in China I hear that same collaterals (mostly Cu and other commodities) were used many times over for loans from sucker foreign banks who are fighting over who owns the collateral…

    Folks debt is either paid off or defaulted and I sense more default bombs going off but you can bet that the banksters will continue to insists that loans in technical defaults are not nonperfoming loans in their books as otherwise it will hit their books really bad with nonperforming asset skeletons galore miscategorized as “asset”…

    TARP II plus RTC (for those old enough to recall Resolution Trust Corp to mop up 80’s savings and loan mess) anyone?

    • Petunia
      Jul 17, 2015 at 2:14 pm

      Speaking of AIG they have a long history in China selling insurance. I would find it hard to believe they haven’t sold a ton of CDSs over there. When the NYSE went down last week the tv guy was pointing to the AIG screen showing no bids. I was waiting to hear AIG was the reason they had to unwind trades, still am.

      • Paul
        Jul 17, 2015 at 3:22 pm

        I’d be a little concerned as a Chinese rep for AIG.
        The PROC have a debt resolution program that is a bit different than the somewhat lackadaisical US regulatory approach.

        A small but effective 9mm. in size.

  9. Paul
    Jul 17, 2015 at 3:10 pm

    And just like the 08 mortgage blowup, no one will serve time for fraud.
    Average Joe’s $100,000 ‘investment’ in one of these hapless funds loaded down with high yield crap paper like this ends up with a box of used test tubes and specimen cups for his retirement while the top execs of Millennium walk away with millions.

  10. interesting
    Jul 17, 2015 at 4:27 pm

    “And $1.297 billion was used to fund a special dividend to its owners”

    and there it is right there!!! borrow money to pay off the insiders all the while KNOWING the ship is sinking, what a joke the economy has become. And how is this legal?

  11. JonMan
    Jul 18, 2015 at 3:47 am

    If this thing goes into 11 (which seems likely), one should expect that creditors will seek to claw back the “dividend” and parent loan repayment as fraudulent transfers. Thankfully, “covenant-lite” means nothing in bankruptcy — although I suspect it may generate a lot of interesting litigation during the next distressed cycle.

  12. SolidCollateral
    Jul 20, 2015 at 12:15 am

    This is a fantastic article –
    Hopefully the criminal banks that pawned this garbage loan off can be taken to task for not thoroughly disclosing known risk factors. Right on JonMan that some interesting litigation will enSUE!
    Buyers of this debt should be engaging more due diligence to be sure. Everyone has a part to play. That notwithstanding, hopefully clawbacks will rescue a few pennies that may be rolling around after all the lawyers get theirs.

  13. Jul 21, 2015 at 7:45 am

    In the space of only a year or so, the 10-year UST rate is about 100 bps higher, whereas junk bond yields and leveraged loans are about even or lower (particularly in the case of leveraged loans). How is that congruent to what we know about markets?

  14. Gadi
    Jul 22, 2015 at 5:15 pm

    Why blame Millennium? blame the lenders. They knew that the money would be paid as dividends. This is pretty much standard practice with these leveraged buyouts. They also knew about the blacklists, and the issues with selling the debt. These institutional investors should not have been placing people’s money in such a deal. The people at Oppenheimer, Fidelity, and Franklin probably got big bonuses for ‘investing’ the money. They didn’t care that it will never be returned. JPM, Oppenheimer, Fidelity, Franklin, Millennium were all in this together, soaking fees and leaving the fund investors holding the bag.

    • Jul 22, 2015 at 6:24 pm

      You’re right, Gadi. And I did blame the lenders. I said they had “Jell-O” between their ears: “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.”

      So while I was at it, I even blamed the Fed :-]

      Every element about this deal is sordid.

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