Lay Down, Roll Over and Be Dead

zombies

Adverse market conditions.

The final season of a long-running zombie drama treats the undead as little more than scary scenery. Alarming, but hardly a real threat. That could be a big mistake. The Walking Whatnow? No, no. I’m talking about the corporate bond market.

November was arguably the worst month for bonds since 1994. Volatility was up, junk and investment grade sectors sold off, and the yield curve flattened to a bearish extent not seen since 2007. The (once) market-darling investment-grade bond ETF, LQD, is now down 5.3 percent year to date. The TLT long-term Treasury ETF is down 3.2 percent on the month.  

Yes, Jay Powell is reportedly getting the vapors about taking away Donald Trump’s punchbowl, but the market is sure rates will rise on the 19th nonetheless, and the Fed boss has cannily announced that he will give a press briefing after every FOMC meeting going forward – meaning that the committee will have a lot more flexibility about when it changes rates. (Now it does so only at the meetings that feature press conferences.)

Well, so what. Rates are still low, employment and inflation numbers look good. But take a look at the massive increase in business debt in recent years – it is now $32 trillion, over three times the size of the mortgage debt that almost sank the global economy in 2007-08.

As rates rise, and a lot of that debt needs to be refinanced, some of those zombie companies that have survived on the “accommodative” nature of the junk markets in recent years are going to be in trouble. Suddenly, cash flow negative starlets like Tesla and Netflix, which have to borrow to keep the lights on, might lose their luster. And market leaders that have done really, really stupid things, like Apple, which borrowed $150 billion to buy back stock, could rue their fates when it comes time to refinance.

That may be soonish. Most fixed rate corporate debt has a maturity around five years; companies have been on a debt binge for five or more years, hence talk today of the coming fearsome “wall of maturities”. In May, Bloomberg estimated that $4 trillion would have to be refinanced in the next five years. More recently, BNP said S&P 500 companies alone have $1.6 trillion to refinance over the next three years – nearly 4.5 times as much as they had to refinance going into the financial crisis in 2007.

As market watchers shriek in horror as GE, with its $135 billion in debt, makes its shambolic way down the credit curve, other zombies are queuing up at the door. Time for investors to keep their, uh, brains about them.

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After 18 Years, Watchdogs Set to Leash Credit Swaps

RISK reports that the CFTC and SEC are partnering to oversee single-name credit default swaps, something required under Dodd Frank. This could bring to an end the damage, potential and actual, created by the product in the 18 years since the disastrous Commodity Futures Modernization Act of 2000 left over-the-counter derivatives completely free of regulation.

From RISK:

The top US markets regulators have reached a tentative agreement to jointly regulate single-name credit default swaps (CDS), Risk.net has learned. The deal will pave the way for the Commodity Futures Trading Commission to propose a clearing rule for single-name CDS, fulfilling a key provision of the Dodd-Frank Act.

CFTC chairman Christopher Giancarlo discussed the agreement in a behind-closed-doors meeting with industry participants on March 13.

Neither regulator covers itself in honor on a regular basis, but the SEC is known to be more conservative in its views. Whether it will re-litigate the “insurable interest” question that CDS critics have leveled at those who take naked short positions (pretty much everyone in the market, that is), is unclear. But as RISK notes, this could be a step toward central clearing, moving credit products toward the same fate as interest rate derivatives, cratering dealer earnings but reducing systemic risk.

Unless, like me, you worry that clearinghouses just concentrate risk. But that’s another story.

Treasury Sets Stage for Financial Crisis Sequel

The good points in Treasury’s Dodd Frank reform priority list – in particular, acknowledging that cranking up regulatory capital requirements made the corporate bond market a LOT less liquid, and therefore prone to crisis – are overshadowed by one piece of truly head-shaking stupidity.

Treasury seems to have forgotten – or perhaps it never understood (or, more likely yet, just wants to cut its pals at the once and future wards of the state on Wall Street a break) – that it was all that super-senior synthetic CDO crap, requiring nearly no regulatory capital, that blew banks apart when the ratings firms realized their models were all wrong in 2007-08.

downloadBanks stuffed to the gills with that gilded manure – they couldn’t sell it, after all, initially because it yielded zilch and later because no one wanted to catch a falling knife – were suddenly insolvent when the three blind mice began their panicky widespread ratings downgrades and the squillions of super-senior crammed in banks’ attics suddenly started requiring – yup – lots of regulatory capital.

This proposal is doubly idiotic, since it assumes that investors will want to buy this stuff when it is declining in value, just when those investors themselves are scrambling to sell their own liquid assets to meet the true bogeyman of the crisis, the promised panacea that turned out to be the virulent contagion that spread the trouble from one basket of eggs to the next and pushing asset class correlations inexorably, painfully, toward 1 – the magic of collateral and margin calls.

From the FT:

The report seeks to soften bank capital requirements for securitised products, lowering some calculations in line with international recommendations. It also suggests the highest quality layers, or “tranches”, of debt should count towards banks’ liquid assets able to be sold in a crisis to raise cash, helping them meet another international regulatory requirement.

Oh boy.

via Five takeaways from the Treasury’s deregulation report

Corporate and Buyout Debt Levels In the Red Zone – This Time It’s Different, Right?

The Wall Street Journal, which didn’t exactly cover itself in glory with its reluctant and initially Pollyanna-ish coverage of the 2007-8 LBO and debt market meltdowns, is now sounding the alarm – on its front page no less:

Risky Loans Surge in U.S., Overseas

(Website headline: Leveraged Loans Are Back and on Pace to Top Pre-Financial Crisis Records)

Investors worry this could pressure financial markets if global economic expansion fades

Lending to the most highly indebted companies in the U.S. and Europe is surging, a development that investors worry could pressure financial markets if the global economic expansion starts to fade.Volume for these leveraged loans is up 53% this year in the U.S., putting it on pace to surpass the 2007 record of $534 billion…

Sure, the piece is essentially just LCD’s data through the WSJ’s megaphone, but it’s a step in the right direction, and, really, they had to get the worry beads out in the wake of Toys R Us.

Wolf Richter crunches his own numbers in a more insightful piece from yesterday (Corporate Mirage: Debt out the Wazoo, Sales Languish, Stocks Soar) that illustrates the absurdity of the current debt/sales/share price trend lines, and is well worth reading.

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In short, debt jumped 35% since the prior peak before the Financial Crisis, as sales rose only 12% over the same period, but stocks have doubled from the highly inflated levels at that time.

It’s all part of the phenomenon of repressed yields and cheap credit: Companies are borrowing large amounts of money to buy back their own shares and to buy out each other, instead of funding investments in productive activities. The hype around these share repurchases and M&A fires up stock prices and contributes to the current stock price bubble, but does nothing for the economy and leaves corporate America and share prices in a very precarious position.

So is Toys R Us the Tribune of the new unwinding? As Richter writes, “Hype works, until it doesn’t.”

Alphaville: 1980s Credit Crisis Was Dress Rehearsal for 2000s.

Will people read across to the present day? Nah… this time it’s different.

They take advantage of differences in the timing of bank deregulation across US states in the 1980s — specifically, limits on both inter-state and intra-state branches — to measure the importance of “credit supply shocks” for employment, consumer spending, house prices, indebtedness, and inflation. States more willing to let banks from other states enter their market, such as New York, had bigger booms in the 1980s and bigger busts subsequently when compared to places less open to financial-sector competition, such as Illinois.

These booms took the form of greater household borrowing, significantly faster inflation, and a big uptick in the size of the notoriously unproductive construction sector. Rather than encouraging worthwhile investments, easier lending standards only exacerbated the amplitude of the cycle:

via Anyone awake in the 1980s should have known about the dangers in the 2000s | FT Alphaville

After Massive Loan Growth Under Obama, Credit Stalls Under Trump

Coincidence? Via Wolf Street:

US-commercial-industrial-loans-2012_2017-05-10Over the past five decades, each time commercial and industrial loan balances at US banks shrank or stalled as companies cut back or as banks tightened their lending standards in reaction to the economy they found themselves in, a recession was either already in progress or would start soon. There has been no exception since the 1960s. Last time this happened was during the Financial Crisis.

via Oops, this Wasn’t Supposed to Occur in a Rosy Credit Scenario | Wolf Street