“Opportunities in Distressed Assets” as current investors get crushed
After seven years of “emergency” monetary policies that allowed companies to borrow cheaply even if they didn’t have the cash flow to service their debts, other than by borrowing even more, has created the beginnings of a tsunami of defaults.
The number of corporate defaults in the fourth quarter 2015 was the fifth highest on record. Three of the other four quarters were in 2009, during the Financial Crisis.
At stake? $8.2 trillion in corporate bonds outstanding, up 77% from ten years ago! On top of nearly $2 trillion in commercial and industrial loans outstanding, up over 100% from ten years ago. Debt everywhere!
Of these bonds, about $1.8 trillion are junk-rated, according to JP Morgan data. Standard & Poor’s warned that the average credit rating of US corporate borrowers, at “BB,” and thus in junk territory, hit a record low, even “below the average we recorded in the aftermath of the 2008-2009 credit crisis.”
The risks? A company with a credit rating of B- has a 1-in-10 chance of defaulting within 12 months!
In total, $4.1 trillion in bonds will mature over the next five years. If companies cannot get new funds at affordable rates, they might not be able to redeem their bonds. Even before then, some will run out of cash to make interest payments.
A bunch of these companies are outside the energy sector. They have viable businesses that throw off plenty of cash, but not enough cash to service their mountains of debts! Among them are brick-and-mortar retailers that have been bought out by private equity firms and have since been loaded up with debt. And they include over-indebted companies like iHeart Communications, Sprint, or Univsion.
The “end of the credit cycle” has dawned upon the markets. As credit tightens, companies that can’t service their debts from operating cash flows may be denied new credit with which to service existing debts. The recipe of new creditors’ bailing out existing creditors worked like a charm for the past seven years. But it isn’t working so well anymore.
What follows is a debt restructuring — either in bankruptcy court or otherwise.
Money is now piling up in funds run by private equity firms, to be deployed at the right moment to profit from this. But not by playing the entire market, or to bail out existing investors. No way. This money will be deployed at the expense of existing investors.
One of the biggest players is PE firm KKR, which just raised $3.35 billion to take advantage of opportunities in “distressed assets.” Existing investors, brace yourself!
Few PE firms have lost as much money in energy as KKR. It masterminded the largest LBO of all times, the $44-billion buyout in 2007 of TXU, which went bankrupt in April 2014 with $50 billion in debts. And its $7-billion buyout of natural gas driller Samson Resources ended up in bankruptcy last year. These two deals combined have cost KKR about $5 billion.
This may be why KKR is still a little shy about energy.
Jamie Weinstein, member of KKR’s credit portfolio management committee, told Bloomberg in the interview below that he was not ready to dive into the massively distressed assets of the energy sector. It’s “too early,” he said. The crushed prices aren’t nearly crushed enough!
And yet, despite the soaring defaults in corporate America, it’s just the beginning in this “life cycle of increasing defaults,” he said.
A PE firm is not a humanitarian non-profit. It’s not trying to help out prior investors. Prior investors – bondholders and shareholders alike — are going to lose their shirts once KKR gets in on top of them in the capital structure of the company and lead it into, or out of, a debt restructuring in order to, as he puts it, “unlock” the company.
KKR isn’t the only PE firm lusting for these opportunities. A lot of wealth is going to get transferred at the end of this credit cycle.
A fascinating, chilling interview. Just 5 min. You might see an ad at the beginning, Bloomberg’s way of making a buck. But the interview is worth the wait.
These PE firms are considered the ultimate “smart money.” They understand the markets. They can read trends. They know when to get in and when to get out. And yet, a lot of them got caught at the end of this credit cycle, and now they’re waiting for a miracle. Read… How the Ultimate “Smart Money” Got Stuck in the IPO Pipeline