Crackdown efforts by bank regulators are put on hold.
The volume of leveraged loans – the riskiest loans Wall Street banks provide – has surged 38% year-over-year and has already beaten the full-year record set in 2013, according to Dealogic. Total of leveraged loans outstanding has reached $1.25 trillion.
Nine of the 10 largest banks in the leveraged-loan business have already surpassed their respective 2016 full-year totals, according to Bloomberg data, cited by the Financial Times, including Bank of America (about $120 billion in leveraged loans so far this year); JP Morgan (about $110 billion), Goldman Sachs ($79 billion); and Barclays ($72 billion). Of the top ten, only Wells Fargo ($69 billion) is still lagging behind last year.
The fees that the banks are raking for putting these loans together are also record-breaking: $8.3 billion so far this year, just 6% below the full-year total of 2016.
The borrowers are junk-rated over-indebted companies. Leveraged loans are too risky for banks to keep on their balance sheet. So banks structure these loans, arrange them, and sell the structured products to loan mutual funds or ETFs so that they can be moved into retirement portfolios, or they repackage them into Collateralized Loan Obligations (CLO) to sell them to institutional investors, such as mutual-fund companies.
Leveraged loans are bought and sold like securities. But the SEC, which regulates securities, considers them loans and doesn’t regulate them. No one regulates them.
Since 2013, bank regulators – the Fed, the OCC, and the FDIC – have been exhorting banks to be prudent with leveraged loans, and they’ve been trying to crack down on leveraged lending because banks got stuck with these loans during the Financial Crisis. But that crackdown – however ineffectual it might have been – is now on hold because earlier this month, the Government Accountability Office questioned the legality of the standards set by the regulators.
And given the big-fat fees – potentially hitting $10 billion this year – banks are in no mood of cutting back.
But it’s not new loans that are booming. Companies aren’t borrowing that much. In fact there’s a dearth of new loans, given the feverish demand for them. The surge in leveraged loans is instead driven by companies that are renegotiating and refinancing existing loans to lower interest rates, accounting for over 60% of the total leveraged-loan issuance this year.
This is possible because credit markets have gone nuts in their all-out ferocious hunt for yield. There is so much demand from investors for these slightly higher yielding products that companies have the upper hand in setting the price.
“Net new supply is relatively low so demand is exceeding supply,” Christina Padgett, an analyst at Moody’s, told the Financial Times. “Investors are going to get squeezed on price and the issuers are going to take advantage so they have really flexible credit agreements.”
Leveraged loans are used to fund mergers and acquisitions; they’re a big financial tool for private equity firms. Their over-indebted junk-rated portfolio companies issue leveraged loans to fund the leveraged buyout, or to fund a special dividend back to the PE firm. But now the big thing is refinancing existing loans with even cheaper new loans.
“Transactions can get financed at very attractive levels,” Christina Minnis, global head of acquisition finance at Goldman Sachs, told the Financial Times. Year-over-year, Goldman has more than doubled its leveraged-loan book. “It’s booming,” she said.
In an environment where central banks have crushed yields, investors have become so desperate for any yield they can get, no matter what the risks, that borrowers are totally taking advantage of this desperation. Not only are leveraged-loan yields bouncing along record lows, but the investor protections written into the loan covenants have deteriorated to the point where “covenant quality,” as measured by the FridsonVision series, has reached a record low in the third quarter (chart).
These “covenant lite” loans made up 82% of all leveraged loans in the first half of October, according to LCD. As of September 30, 73% of all US leveraged loans outstanding had a covenant-lite structure, the highest proportion ever. So investors are going to be in for a rough time when the tide turns, and they realize that customary protections are lacking.
Most of the brick-and-mortar retailers that have filed for bankruptcy protection over the past two years have been owned by PE firms, including Toys ‘R’ Us. Part of how PE firms make money is by stripping capital out of their portfolio companies via special dividends funded by leveraged loans. So just how much have PE firms paid themselves in special dividends extracted from their portfolio companies? Read… Asset-Stripping by Private Equity Firms Is Booming
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Are they getting ready for a subprime replay of 2007 – 2008 down the road? This is shocking stuff. So is the $319.04 per hour ($622,000 per year) wages being paid to linemen restoring power in Puerto Rico from a $300 million contract to Whitefish Energy, a Montana firm that had only two employees when hurricane Maria struck PR.
“Whitefish, Mont., is the home of Interior Secretary Ryan Zinke, although the company said he played no role in securing the business. One of Zinke’s sons worked for Whitefish Energy over the summer.” – Washington Post
When 3.5 million people are down and out, 80% are without electricity, it seems people high up are carving out $millions from Puerto Rico’s misery.
Getting ready for a subprime replay ? Hell JoA .. they’ve been pushing for it ,working steadily at is and on their hands and knees begging for it since the last of the bailouts came their way only ten times worse .
Unhinged hyper-capitalism verging on anchro- capitalism at its finest .
You keep saying hyper-capitalism and an across-capitalism, but these things have nothing to do with capitalism.
In free-market capitalism winners and losers are not choose by the government. The last time you probably experienced capitalism was when you traded food items in elementary school.
I don’t understand why anyone would buy a company after it has been bled dry by PE. I guess it doesn’t matter to the PE because they can get their investment and profit through special dividends, before even getting to a sale?
Is that the normal case, I wonder. You would think workers would fight such buyouts tooth and nail.
How can the workers fight? Labor unions have been marginalized and in decline for a generation. The few survivors have been bought off by the pols, e.g. Obama’s 19% gift of GM stock to the UAW during the bailout.
Aside: I am 86 and have never seen such bitter cynicism and resentment toward all of our institutions, here and abroad, since the 1930’s great depression.
I’m 64, and it’s likely I’ll live long enough to think of the pre-Trumpian time as ‘the good old days.’
Yes because the massive debt that preceded him posed no threats to long term fiscal sustainability?
Let’s play a game called name that president. What President forced lenders to end to people who could not afford housing (CRA), while at the same time repealling the Glass-Stegal Act? Both of these decesions engineered one of the biggest housing bubbles in American history.
here we go again. The coming bailout is going to make 2008 look like a walk in the park. And why not take any risk when you know the tax payer has your back?
Swamping the Drain.
Two thumbs up !
Gonna have to borrow that one if you don’t mind !
Same here. I will borrow that. Another example of its validity:
Congress votes to disallow consumers from suing Equifax and other companies with arbitration agreements
24 Oct 2017
The Senate voted late Tuesday night to strike a federal rule that would have allowed consumers affected by the Equifax hack to sue the company. Without it, the millions affected by the historic security breach may be disallowed from related joining class action lawsuits. This specific rule, and only this rule, would be nullified if the joint resolution is signed by the President.
The vote was 50/50, with the tie-breaking yea cast by Vice President Pence.
P/e firms are immoral,unethical ,but LEGAL.I have a great deal of concern about those people who are laid off when companies enter bankruptcy.And it is not just P/e firms.Uncle Warren’s takeover of Heinz probably is good for him ,but slashed costs(meaning workers) to the bone.He is a hypocritical, prevaricating wolf in sheep clothing who is not shy of using the government’s largess when needed.
What is underlying this behavior?The attitude of managers ,who have been taught that maximizing profits and stock prices is the raison d’etre of corporations and our incredibly stupid tax laws ,which enable such behavior.
Henry Ford ,who was hardly an angel and had numerous disputes with organized labor, understood that he needed well paid employees to buy his products.The current crop of managers have an attitude of to hell with the average worker as long as they can get their absurdly high compensation.They export jobs overseas and beg Presidents to allow them to import workers under the H1-b program
Stupid tax laws combined with a rapacious attitude among top corporate managers guarantee the destruction of capitalism; the only question is WHEN.
A useful resource about PE firms is the Eileen Appelbaum and Rosemary Batt book.
Private Equity at Work: When Wall Street Manages Main Street.
And with cheap credit ending we are gonna see some quite expectacular crashes.
What’s interesting is that the US banks seem to be taking on a lot more risk whereas the European Banks are de-risking massively from their balance sheet, headcount and branch numbers.
2.8 million work for European Banks currently, Nordea have just stated they are getting rid of 20% of their staff, the other European Banks will follow suit.
Obviously the European Banks have been burnt massively and still dealing with the mess, I just hope the American one’s aren’t in five years time.
If “investors have become so desperate for any yield they can get, no matter what the risks”, why don’t they just buy equities?
If you make the assumption that Wall Street is regulated and supported by the USG, for the benefit of corrupt politicians, then you can make the case that private capital represents an improvement in the situation.
“They’ve been trying to crack down”
Yeah, sure! Come on be real, was there ever any question that regulators (FDIC for one) wouldn’t step aside in the free-for-all that’s been in place for decades? Ever noticed they say one thing to sound like they’re the good guys and then do completely another?
Most of the problems we face can easily be solved with some common sense. The h1b employee if necessary and more valuable than us employee then a10 to 20% surcharge needs to be added to their salary above what a us employee would receive.If a company is comfortable with non-GAAP earnings. Then they should be comfortable with the IRS adjusting their tax bill accordingly .Things can change.
When debt is a ‘product’, no great surprise that things get weird.
When it becomes a nation’s main product – because it’s outsourced its real wealth-creating manufacturing base abroad – then you have real problems.
Certain countries that have gleefully allowed their mass-manufacturing base disappear abroad and replaced it with debt-fuelled consumption (easy way to get elected) are now finding out the problems the hubris of the ‘easy option’ are creating.
from zerohedge: “The S&P is substantially overvalued on 18 of 20 valuation metrics, with the only exceptions being free cash flow (helped again by depressed capex), and relative to small caps/bonds – the Fed’s favorite indicator – …”
As Wolf has before shown, the small caps in question, the Russell 2000, is no real comparison as the ‘official’ figure only includes companies with earnings, and the real earnings of the R2K is or was ~zero. And so one of the ‘Fed’s favorite indicators’ is bogus. And so the S&P is overvalued on 19 of 20 valuation metrics, if done more honestly. (E&OE)
And yes it does have something to do with the leveraged loans.
No surprise that Fed’s fav indicator is bogus.
2008 Goldman Sachs Trader called Bundled Sub-Prime Mortgages “Dog Shit”. Leveraged Loans fall into the same category.