The Haves & Have Nots: Credit Crunch Part II, and The End of the Walking Dead

The walking dead and the end of the thirst for yield

As rates stayed low - just not as low as they are today - more and more companies with “just OK or bad” balance sheets borrowed and borrowed from 2009 through 2020 (to date) thanks to the massive appetite for yield, which resulted in lots of corporate bank loans and high yield bonds on the balance sheets of banks and inside portfolios of fund managers trying to make money, beat benchmarks (or just collect fees and pretend they’re experts).

The bond market’s size is huge - it is way larger than the global equities. As of 31 December 2018, for example, the entire US bond market (bond debt outstanding) was at $102.8 trillion, according to SIFMA. In comparison the US equity market capitalisation was $74.7 trillion (SIFMA Fact Book 2019).

Loan issuance generates fees. Bond issuance generate fees. Both types of financing grow assets for banks and justify what your (pension) fund manager can do with all the trillions of assets under management.

High yield funds look like this Black Rock’s HY fund or this iShares HY ETF

These large loans and bonds (some backed by sub prime car loans, student loans and high interest credit card debt) and smaller loans to smaller companies have created an army of the walking dead too - small, medium and even large companies that don’t have enough income in the form of EBIT (operating profit) to service their “mortgages”.


The zombies’ share of the market appears to be growing. About 17% of the world’s 45,000 public companies covered by FactSet haven’t generated enough earnings before interest and taxes (EBIT) to cover interest costs for at least the past three years. Bank for International Settlements economists, using a similar but narrower definition, find that the world’s equity markets’ share of zombies has risen to more than 12%, up more than 8 percentage points since the mid 1990s.

If you couldn’t afford it, you could still borrow it - but only if you could convince a bunch of investors - including Black Rock and others - that you could borrow later again to repay what you couldn’t afford in the first place. The fees were great but the party has ended.

Until next time.

FT today:

Corporate borrowing costs soar amid default fears

Interest rates for even highly rated companies double from levels of days ago

Borrowing costs for companies around the world are rising dramatically despite central bank interest rate cuts as rating agencies warn that the economic impact of the coronavirus will lead to a surge of corporate downgrades and defaults.

Fears about creditworthiness are prompting investors to put their money in the most easily traded securities — such as short-term government debt — raising borrowing costs for more highly rated corporate borrowers and choking off credit to riskier ones.

Rating agency Moody’s estimates the default rate for speculative-grade companies could hit nearly 10 per cent, with energy companies particularly hard hit. That is up from 2.3 per cent a year ago, and a historical average of 4 per cent.

“I think the pandemic coupled with the oil price crash and the asset price declines are creating a severe and extensive credit shock across regions, sectors and markets,” said Anne Van Praagh, a researcher at Moody’s.“The combined credit effects are unprecedented. This is not like anything we have seen before.”

(Moody’s on its site says: “Anne re-joined Moody’s in June 2009 following three years at Morgan Stanley. There she worked as an investment banker on 30 senior managed financings in transportation and infrastructure. During the preceding eight years, Anne worked on a variety of Moody’s rating teams within the US Public Finance Group, including in the US states and infrastructure ratings team.”)

Even highly rated companies that have been able to sell bonds during the outbreak have agreed to deals that will increase their total financing costs by hundreds of millions of dollars as revenues are threatened by an economic downturn.

The average yield for investment-grade corporate debt has risen from a year to date low of 2.26 per cent two weeks ago to almost 4.5 per cent on Thursday, according to an index run by Ice Data Services.

“It’s brutal. We have never seen such a big move in such a short amount of time,” said Monica Erickson, a portfolio manager at DoubleLine. “This is the quickest and most severe I have ever experienced, and I was around for 2008.”

For higher-risk “junk” rated companies, the sell-off has been even more severe, with the average yield on an index run by Ice doubling this month to over 10 per cent.

“Companies are focused on increasing liquidity, drawing down revolvers and accessing cash wherever possible. They are preparing for the worst because we are in an unprecedented environment,” said Ms Erickson.

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If it’s in the news, it’s already late for some.


Credit spreads getting similar to 2008-2011 levels.

Demand for safer “good quality” Investment grade bonds issued by more solid companies also affected:

Investors are fleeing corporate bonds at a record pace, sending down shares of funds that buy investment-grade debt at a magnitude not seen since the financial crisis of 2008, according to Bank of America research.

The bank’s credit strategists last week sounded the alarm on high-yield debt, saying it was quickly nearing “the point of no return” as coronavirus concerns ripple through the markets.


The premium investors demanded to hold riskier junk-rated credit rose to 904 basis points over safer Treasury securities on Wednesday, its highest level since 2011, according to the ICE/BofA high-yield index .MERH0A0.

A deep dive into high interest illiquid high risk loans or…

2008 again?

Investors love debt. But is shadow banking hiding risks that should be plainly visible?

Institutional investors have been pouring money into private credit, with direct lending funds now dominating the scene, according to Preqin, a provider of alternative-assets data. They’re betting on an area of the nonbank lending market whose rapid expansion since the crisis has not been tested in a downturn. And they’re locking up capital with funds that hold loans that don’t trade.

At the start of July, direct lending funds were aiming to raise $98 billion globally, more than half the total sought by other private credit pools, including mezzanine, distressed debt, special situations, and venture debt funds. They’re adding to record dry powder exceeding $100 billion, a pile of uninvested capital that has soared from $23 billion for direct lending in 2012, Preqin data show.

Wells Fargo & Co., JPMorgan, and Citigroup are among the big U.S. banks that invest in CLOs, according to Insull. Japanese banks have also been investors, he says, along with insurance companies, pension funds, and asset managers.

Banks tend to own the safest and largest portion of CLOs, the so-called AAA-rated tranche, says Insull. “It’s really hard to get hurt,” he says. “The amount of loss you’d have to realize before that play would be impaired is tremendous.”

At least one asset manager, Schroders, isn’t taking any chances investing in the riskier portions of CLOs.

“We are only investing in AAA-rated classes,” says Anthony Breaks, a New York-based fund manager in the firm’s securitized credit group. “We are being very selective about our CLO investments because we continue to be concerned about the quality of the loan market.”

A CLO, backed by a portfolio of leveraged loans, issues a series of bonds of varying risk and return. The so-called equity tranche is the riskiest because it’s at the bottom of the stack, where investors are first to take a hit should problems arise with the underlying assets.
Citigroup, which pegs the U.S. CLO market at about $640 billion, estimates that banks represent 46.5 percent of investors in the AAA-rated portion of the structured loan pools. Asset managers and insurers are the next biggest buyers of that safest and largest tranche, the bank’s research shows.

The majority of CLO mezzanine, meanwhile, is held by asset managers and insurers, with pension funds being the third biggest group. The equity piece is mainly held by asset managers.

In the world of shadow banking, private equity firms are everywhere — and are fueling its boom.

They’ve been on a tear raising buyout funds that purchase companies small and large, relying on nonbank lenders to finance their deals. They turn to direct lending funds for acquisitions in the midmarket, and for larger deals, ask CLOs and other investors for deal financing.

They also sit on the other side of the table, creating CLOs and powering the private credit boom with their own direct lending funds. For example, Carlyle Group announced this month that it closed a $2.4 billion fund that will provide direct loans to upper-midmarket borrowers, including companies that are not backed by private equity firms. With leverage, Carlyle Credit Opportunities Fund can invest as much as $3.1 billion, the firm said.

There’s a movie about this already:


Hats off @engineer - Amazing post.


The bond fire sale has started


The AlphaCentric Income Opportunities fund lost more than 30 per cent of its value this week owing to its heavy exposure to home loans to borrowers with lower credit scores

What’s a fire sale like?

To illustrate it, it’s better to watch this scene from Margin Call - a film about a brokerage firm which had a lot of bad bonds on its trading books. The management learned that its risk models showed they were going to suffer big losses, so it decided to dump these asset-backed securities onto less suspecting buyers. The person who discovered these losses - a risk manager - lost his job but recieved a nice package.

Starring: Kevin Spacey, Paul Bettany, Jeremy Irons, Zachary Quinto, and many others:

“96 on the dollar” means the debt price - according to the person who makes the market - is 96% of the 100 cents - implying there’s a 96% chance it’ll get repaid in full or you’re getting a nicer yield than originally. Or it means something else. When bonds are at 40 cents, it can signal that e.g. Aston Martin is in distress, but they can also jump to Virgin Galactic levels and stay up like Tesla. It’s a game of confidence.


“Mutual fund seeks offers on $1bn of mortgage bonds.”

A year prior to Lehman’s collapse, there were early publicly known signs that subprime debt was in trouble (as if it the word “subprime” wasn’t a big red flag to investors already).

Here’s some Wikipedia knowledge on Bear Stearns funds (Bear Stearns no longer exists):

On June 22, 2007, Bear Stearns pledged a collateralized loan of up to $3.2 billion to “bail out” one of its funds, the Bear Stearns High-Grade Structured Credit Fund, while negotiating with other banks to loan money against collateral to another fund, the Bear Stearns High-Grade Structured Credit Enhanced Leveraged Fund. Bear Stearns had originally put up just $25 million, so they were hesitant about the bailout; nonetheless, CEO James Cayne and other senior executives worried about the damage to the company’s reputation.[10][11] The funds were invested in thinly traded collateralized debt obligations (CDOs).

CDOs, CDOs of CDOs and synthetic CDOs were much worse than simpler debt backed by mortgages of lower credit scoring mortgage owners, but it’s just an example.

Let’s carry on with that FT article:

A $2.3bn mutual fund sought offers on more than $1bn of mortgage bonds on Sunday to cover investor withdrawals after booking heavy losses in the market turmoil.

This “Income Opportunities” fund is selling almost half of the stuff it had under management. It the value of those assets is, say, 50 cents, than it’s a $2.3bn fund that is actually a $1.8bn fund (best case scenario?)

Now that’s an income opportunity.

The AlphaCentric Income Opportunities fund lost more than 30 per cent of its value this week owing to its heavy exposure to home loans to borrowers with lower credit scores. The fund’s public filings show that at the end of 2019 — when it still had $4bn in assets — it had invested two-thirds of its portfolio in bonds backed by subprime mortgages.

Because they lost 30% mark-to-market, it doesn’t mean that’s an actual loss. The nature of the stuff we haven’t seen yet may be that it’s so illiquid, whoever decides to buy that (probably a distressed fund seeking to pay 10 cents?), will dictate a much larger loss.

There may be a lot of distressed debt funds seeking income opportunities right now - buy very low, wait, sell higher later. (For example:

The mortgage market has come under broad pressure this week, as some investors began to doubt homeowners’ ability to repay their loans. Two traders said that the fund’s portfolio managers sought offers from potential buyers on a list of more than $1bn of securities to raise cash.

What’s also interesting, again, is that when the times were “good”, these high yielding high risk asset-backed securities funds were considered as absolute geniuses (as long as they weren’t losing money, which was dictated by the market perception of the value of their assets, and probably not their talent - sorry).

The mutual fund, which carries the highest, five-star rating by influential investment research firm Morningstar, offers its investors the chance to withdraw their money on a daily basis.

(… 5 stars :star: :star: :star: :star: :star: )

The AlphaCentric Income Opportunities fund last year won an award from Thomson Reuters’ fund research service Lipper, which said that it had the highest consistent return out of more than 260 funds in its category over three years.

(… Award-winning)

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Here’s an example of some other crazy thing that happened in 2007:

(Source -

If it was happening in 2007, there’s a high chance there’s plenty more like that happening right now.

Don’t be a retail investor chump.

And stay indoors.



Smells like the summer of 2007 - Bear Stearns then, Goldman Sachs and BNY Mellon now:

Goldman Sachs spent more than $1bn to shore up liquidity in two of its “prime” money market funds after a rush of outflows, in the second case of a big bank seizing on new Fed measures to stave off a liquidity crunch in its funds.

A regulatory filing, first reported by Reuters, shows Goldman paid $772m to buy securities from its Square Money Market Fund (SMMF) last week, and another $301m to buy assets from its Square Prime Obligations Fund (SPOF).

The SMMF shrunk by $7.1bn in the week to Thursday, leaving it with assets of $9.6bn, according to industry monitor Crane Data, while the SPOF’s assets declined by $1.7bn to $5.5bn over the same period.

Since both funds trade less than 1 per cent below their net asset value, the reduction in asset value overwhelmingly represents outflows.

Prime money market funds invest in short-term debt, including commercial paper and certificates of deposit. These funds suffered $85bn in outflows for the week ending Wednesday, according to data from the Investment Company Institute. Money market funds that invest in short-term government debt, meanwhile, gained $249bn, as investors rushed into the funds, which are popular proxies for cash.

This is the first time Goldman has acted in this way to protect a fund in its asset management division, a part of the group that chief executive David Solomon promised to turbocharge under the strategic plan he unveiled in January.

Goldman acted in response to an “exceptional climate” for money market funds in the past week, said three people familiar with the situation. The coronavirus crisis has triggered a rush of selling by institutional investors fearing grave economic consequences from the pandemic.

[Column chart of Daily net flows ending March 19 ($bn) showing Goldman Sachs Financial Square]

Money market funds were forced to come up with cash to meet these redemptions. That cash came from their most liquid assets, which in turn pushed a key liquidity measure that only applies to prime funds towards levels that could impose extra fees on investors.

If prime money market funds’ so-called weekly liquid assets (WLA) fall below 30 per cent, they are allowed to impose restrictions on investors withdrawing funds, including added fees — something that limits the fund’s attractiveness to investors.

Last week, the WLA of Goldman’s SMMF fell to 34 per cent while its SPOF had a WLA of 44 per cent. Goldman had a “very high awareness” of needing to meet potential liquidity demands and began evaluating options, said people familiar with the situation.

The funds sold the assets to Goldman’s bank, taking advantage of guidance from the Federal Reserve, which explicitly blessed similar transactions between funds and banks last week in an attempt to improve money market funds’ liquidity.

“This was done at scale . . . (and) in a manner that we felt we could do more quickly (internally) than with another counterparty,” one of the people said, while the second described the assets as “desirable” and said Goldman has “excess cash”.

After Goldman’s actions, the WLAs rose to 46 per cent for the SMMF and 50 per cent for the SPOF.
Trust bank BNY Mellon acted in a similar manner last week, spending $1.2bn to buy assets from one of its funds so the fund would be able to cover redemptions. Goldman has one other prime fund, which is targeted at retail investors. Its WLA is “in the 40s”. Whether the bank would intervene in that fund as well depends on “facts and circumstances” one of the people said.

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Brush up on your insolvency law skills

And the likes of Oaktree are getting ready:

Oaktree Capital, the US-based investment firm that manages about $125bn, is also seeking opportunities in distressed debt across Asia-Pacific, said people familiar with the matter.


The coronavirus outbreak is threatening to force companies across the Asia-Pacific region to default after years of low interest rates prompted many to gorge on trillions of dollars of debt.

In the years following the global financial crisis to 2019, the volume of outstanding corporate debt issued by companies in the region doubled to $32tn, according to Moody’s, the rating agency.

The coronavirus pandemic has sparked a cash crunch that investors fear will cause a wave of bankruptcies in industries from airlines to retail.

“It’s a little bit crazy out there and there are very few sectors that are protected from this,” said John Park, a Brisbane-based managing director at restructuring firm FTI Consulting. “We are seeing an immediate uptick in inquiries from firms seeking advice on how to prevent a potential insolvency event.”

Among the areas causing particular concern is China’s property market. As of February, the industry owed a total of $647bn in bonds denominated in local and hard currencies, according to Dealogic data.
Sales and construction starts both fell more than 20 per cent in the first two months compared to a year ago, according to Plenum China.

Evergrande, one of the country’s largest developers, owes more than $100bn. The company has issued bonds at coupons of up to 13 per cent, a level analysts say indicates anxiety over its creditworthiness.
Beijing may need to bail out such companies, analysts added, with many considering Evergrande too big to fail.

Tahoe Group, a smaller developer, has about $730m in US dollar bonds maturing over the next 12 months. But it has not told investors how it plans to repay them.

“It appears inevitable that the current level of operational disruption, if unabated, will feed through into higher volumes of covenant breaches, and potentially defaults,” said James Dilley, deals advisory partner at PwC, the professional services firm, in Hong Kong, referring to China’s property market.
The pandemic has also caused a funding squeeze in Thailand, where companies have come under pressure as plummeting tourist numbers hit the economy.

Fitch Ratings last week said the asset quality and earnings of the country’s banks would be “significantly weaker” this year.

The agency also pointed to risks to banks in Vietnam, which last suffered a banking crisis in 2012. “There is not a lot available in terms of buffers for the banks in case the economy sharply impacts,” said Jonathan Cornish, head of Asia-Pacific bank ratings at Fitch.

In Australia, the outbreak has prompted a scramble by some companies to raise equity as they struggle with debt repayments. Webjet, a travel company, and oOh! media, an advertising business, on Friday said they would attempt an emergency equity raising.

A number of the country’s companies are also considering invoking so-called safe harbour laws that give directors at insolvent businesses legal protection during restructuring proceedings, according to David Walter, a Sydney-based partner at law firm Baker McKenzie.

“Some sound businesses are drawing down all available liquidity lines or taking on new loans from credit funds with greater risk appetites. This type of debt may be expensive, but it is far better than literally running out of cash,” he said.

Some investors have started sifting through the debt rubble for opportunities.

“Our trading volume has grown exponentially in March compared to last year,” said Michel Lowy, head of Hong Kong-based credit investment group SC Lowy. “The opportunity for business like ours is to try to figure out corporates that are well-positioned from a liquidity standpoint and will have the ability to weather the storm.”

Oaktree Capital, the US-based investment firm that manages about $125bn, is also seeking opportunities in distressed debt across Asia-Pacific, said people familiar with the matter.

But it will take more than adventurous private investors to soothe Asia’s corporate debt issues.

Hamish Douglass, chairman and co-founder of Sydney-based fund manager Magellan Financial Group, told clients this week the coronavirus shutdown would prove fatal for many debt-laden companies.

He thinks governments could follow the example of New Zealand, which on Friday bailed out the country’s national airline with a NZ$900m (US$525m) loan.

“Only governments can prevent these businesses from failing,” he said.

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Unlike large businesses, small businesses have small cash buffers.

Large companies can draw money from banks (until they can’t).


Dash for cash: companies draw $124bn from credit lines

As traditional capital markets seize up, executives are turning to
emergency funding

During the past three weeks, more than 130 companies in Europe and the Americas have drawn at least $124.1bn from their lenders, according to an analysis of public disclosures by the Financial Times and people briefed on the activity. The true figure is likely to be much higher, since publicly traded companies are not required to report the drawdowns immediately and privately held groups often have no obligation to announce them at all.

Back when the world was awash with liquidity, lenders would offer low-cost revolving credit facilities — akin to a credit card — as a perk to win other business. The banks believed that most would never be used in full; such was the stigma of large companies drawing them.

But credit is now harder to come by. The $10tn US corporate bond market, where investors had eagerly lapped up debt offerings from even the shakiest companies, is now reserved for the most well-known and financially sound — the likes of Walt Disney, Coca-Cola and UPS. The short-term commercial paper market has also been frozen, requiring emergency surgery from the Federal Reserve.

Among the first to tap credit lines in this crisis were companies such as Norwegian Cruise Line and Hilton Worldwide, which were acutely hit by fallout from the global health pandemic as customers cancelled trips. But nearly every other industry followed. Car manufacturer Ford borrowed $15.4bn and announced it would shut down factories to preserve cash; brewer Anheuser-Busch InBev raised $9bn as taps stopped flowing; and TJ Maxx-owner TJX and Kohl’s each drew $1bn as they closed stores.

“The economy is really suffering. It has hit an iceberg and nobody knows frankly how long this will last,” said Carlos Hernandez, the executive chair of global investment banking at JPMorgan Chase. “It’s not unreasonable to assume that more businesses will draw their lines.”

Mr Hernandez’s bank has been on the receiving end of more calls about credit lines than any other, the FT analysis showed. JPMorgan had almost $367bn of undrawn commitments to corporate clients at the end of last year — equal to more than 13 per cent of its $2.7tn balance sheet.

Bank of America, Citigroup and Wells Fargo together provided another $1.2tn of lines, while Morgan Stanley and Goldman Sachs had a combined $260bn, according to recent filings with US securities regulators.

This reflects the fact that banks remain “the main source of liquidity insurance” for US companies, according to Sascha Steffen, a professor at the Frankfurt School of Finance, and Viral Acharya of NYU, who studied nearly $1tn of undrawn credit lines held by more than 2,400 US groups. That became clear as the market meltdown began on February 21 and corporate bond, loan and equity markets all gummed up.

“The speed at which companies are already drawing down credit lines is faster than what we have seen before,” Mr Steffen said. If credit markets become even more challenged, the drawdowns could accelerate, he added.

Top financiers warn that cracks are already beginning to form in the corporate world and that the worst is yet to come. Analysts at credit rating agency S&P Global have been working nonstop, downgrading 121 companies and warning of the prospects of another 176 groups in part due to the global health pandemic. Rivals at Moody’s estimate $235bn of debt matures this year and must either be repaid or refinanced, with a further $345bn due in 2021. Rising borrowing costs will pressure companies’ finances after a period when multinationals had binged on debt, and defaults are expected to rise.

The owner of New York Sports Club is one of the groups that has already run into trouble. The indebted gym operator, known as Town Sports, warned late on Friday that it might not be in business in a year as it faces the threat of a surge of cancellations related to the coronavirus outbreak. It is already trying to get its landlords to agree to reduced rent payments. It drew $12.5m from its credit line.

“We have never been in an environment with zero revenues,” said Bruce Mendelsohn, who runs the restructuring advisory business at boutique investment bank Perella Weinberg Partners. “It’s a major paradigm shift. We’re helping all kinds of companies, especially with access to capital: credit lines, revolvers, you name it.

For private groups, the same pressure is on. In Silicon Valley, New Enterprise Associates, one of the largest venture capital firms, with investments in Gwyneth Paltrow’s lifestyle brand Goop and online education platform Coursera, has urged the companies it backs to consider alternative funding strategies including looking to use their lines of credit, according to a presentation reviewed by the FT.

In private equity, some Blackstone and Carlyle portfolio companies have been encouraged to draw their lines of credit to avoid a credit crunch, according to people familiar with the discussions.

The banking system has so far been able to handle the strain of the torrent of capital requests, even as loan officers and bankers process them from home. Senior executives at several of the largest banks told the FT they could write the cheques, even if 100 per cent of their undrawn lines were called in. Even if that proves to be the case, there might be a knock-on impact on other lending, especially if fears mount over companies’ ability to ever repay their credit lines.

“Banks have the ability to meet those draws but it takes away their ability to lend in other areas,” said Bradley Rogoff, a credit strategist at Barclays. “The risk is that if bank capital gets constrained with revolvers. then they can’t lend. They have the capital but then they cannot do anything else with it.”

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HL says this recession will be worse

Houlihan Lokey is a debt restructuring and M&A giant.

“Irwin Gold, executive chairman of Houlihan Lokey Inc., says he sees an economic crisis looming that will be worse than the last recession.”

S&P forecasts high default rates among low credit quality companies

An anticipated recession in Europe will push the European trailing-12-month speculative-grade corporate default rate to 8% by December 2020 from 2.2% in December 2019, with a default risk particularly looming over the oil and gas sector, S&P Global Ratings said.

“The recession that has taken hold in Europe comes at a time when the speculative-grade market is vulnerable to a liquidity freeze combined with an earnings drop,” Nick Kraemer, head of S&P Global Ratings Performance Analytics, wrote in a report. “The percentage of speculative-grade issuers with very low ratings — ‘B-’ and lower — is at an all-time high of more than 20%.”

The rating agency forecasts the global economy to expand 0.4% in 2020, with a 2% contraction in the U.K. and eurozone economies.

With a dent in economic activity, companies’ funds from operations, working capital and liquidity will come under pressure, S&P Global Ratings said. Monetary and fiscal policy measures might be insufficient in reversing a weak business environment completely, and relaxation of requirements in filing for insolvency may not hold back corporates from undertaking distressed exchanges, it added.

Oil and gas defaults

The contribution of the oil and gas sector to the number of defaults will increase amid falling prices in the aftermath of the oil price war between Saudi Arabia and Russia. The sector witnessed the largest spread widening, with the spread climbing more than 1,400 basis points year-to-date. Other sectors that saw a large increase in spreads include healthcare, transportation, and aerospace and defense, according to S&P Global Ratings.

In its pessimistic scenario, S&P Global Ratings projects the default rate to jump to 11% should the recession deepen. It expects spreads to widen further, presenting “a scenario similar in impact to the 2009 financial crisis in terms of economic decline and financial market volatility,” possibly posing a risk to higher-rated speculative-grade issuers.

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Rash of downgrades gives rating agencies sense of déjà vu

Credit rating agencies are scrambling to adjust to the coronavirus pandemic, slashing assessments of vulnerable companies under the scrutiny of critics who blame them for exacerbating the last financial crisis.

The agencies — led by the big three of S&P Global, Moody’s and Fitch — have pushed through large amounts of rating downgrades as the Covid-19 outbreak has accelerated. March had the fastest pace of downgrades, on records going back to at least 2002, according to a report last week from Bank of America. The bank added that more issuers could expect to have their ratings docked in the weeks ahead.

To critics, this is a rerun of the 2008 financial crisis, when ratings that were set too high came tumbling down, magnifying a sense of alarm, particularly in markets for securitised products that were packed with mortgage-backed bonds.

“Here we are, déjà vu all over again,” said Dennis Kelleher, head of Better Markets, a consumer advocacy group. Ratings are being cut “after what appears to be . . . significant ratings inflation, also just like last time”, he said.

Agencies say they are simply reacting to changed circumstances, reflecting sudden strains that have emerged as a result of the coronavirus outbreak. “We are really just trying to call it as we see it, being balanced, but also acknowledging that this is a very big stress that the economy is facing,” said Craig Parmelee, global head of practices at S&P.

About 80 per cent of S&P’s ratings actions since early February — about 213 downgrades out of 4,000 rated non-financial companies — have been on issuers already in “junk” territory before the coronavirus crisis, the company noted.

“We are taking a considered approach to downgrades across geographies and asset classes,” said Anne Van Praagh, head of Moody’s credit strategy and research. “Our job is not to move all ratings down; that does not serve anybody. Our job is to identify the outliers.”

Concerns that ratings were set too high before the coronavirus outbreak stem from the business models of the agencies, which are paid by the companies and the governments whose creditworthiness they assess. A rating from a top agency can make the sale of a bond or a loan much easier, providing investors with notionally independent views of the borrower’s prospects. Such views are also hard-wired into the mandates under which many fund managers operate, forcing them to sell bonds if ratings drop below certain thresholds.

But issuers generally pay to be rated — a structure that can cause conflicts, leading to accusations that agencies compete to win business by offering high ratings.

In 2015, S&P agreed to pay the US and states about $1.4bn to settle allegations that it boosted ratings on mortgage-backed securities in the run-up to the crisis, admitting that it held off on downgrades for fear of losing market share. Moody’s paid $864m in 2017 to settle similar charges.

Today the pair accounts for 81 per cent of outstanding credit ratings, according to a January 2020 report from the Securities and Exchange Commission. Fitch makes up another 13.5 per cent of the market.

Before the outbreak intensified, regulators had been asking questions about the agencies’ business practices. In November SEC chair Jay Clayton said the activities of the agencies should be “continually” monitored, while asking whether there were “alternative payment models” that would better align the interests of rating agencies with investors.

Egan-Jones, a smaller rating agency that is paid by investors rather than issuers, said in a January letter to the SEC that “no amount of disclosure or internal separation of ratings and marketing staff is sufficient to overcome the taint created by such conflicts”.

In their letters of response to the SEC, Moody’s and S&P said potential conflicts were inherent in all rating-agency business models.

Analysts note that the “issuer pays” model also causes some recipients of downgrades to behave as if they are aggrieved customers of the agencies, rather than subjects of unbiased assessments. Last month SoftBank, the debt-laden Japanese group, complained about a downgrade from Moody’s, saying the agency had made “excessively pessimistic” assumptions about the market environment.

Investors often make decisions independently of the assessments of rating agencies. This week, cruise operator Carnival paid handsomely for a new bond issue despite its “investment-grade” ratings, as fund managers judged the company to be in peril after the viral outbreak.

The debate over rating agencies’ business models is unlikely to fade, as this time the scope of cuts is much broader than the realm of structured products. Already, downgrades of big companies such as carmaker Ford and retailer Marks and Spencer, from the lowest rung of investment-grade ratings into junk, have appeared to cause ructions in credit markets.

The old flaws in business models are becoming obvious once more, said Riddha Basu, an assistant professor at George Washington University.

“It is still the same after 10 years,” he said. “Nothing much has changed.”

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Fannie and Freddie could require bailout if lockdown lasts

Regulator says US mortgage guarantors have sufficient resources for about 12 weeks

Fannie Mae and Freddie Mac, the government-controlled companies that guarantee nearly half of US mortgages, could require their second bailout in just over a decade if the US economy remains in a lockdown for several months, their regulator has warned.

The two groups, which collectively underpin the $10tn US housing market, have sufficient resources to last through a lockdown of about 12 weeks, but would then need funds from Congress or the Federal Reserve, said Mark Calabria, director of the Federal Housing Finance Agency.

“If we start to go more than two or three months, then there is going to be real stress in the mortgage market, we’re talking in terms of what happened during the great recession,” he told the Financial Times.

“If we are talking about a drawn-out period where people are not in a position to pay their mortgages, if we are talking about 25 per cent of people having to ask for forbearance, the system doesn’t have that kind of liquidity. That would require Congress to step in, or the Fed.”

Almost 10m Americans have claimed unemployment benefits in the past two weeks, and Congress passed a bill allowing homeowners to forego mortgage payments for up to a year.

About 300,000 borrowers had asked for forbearance on loans backed by Fannie and Freddie as of April 1, Mr Calabria said. Since the agencies make up more than 40 per cent of the mortgage market, he said that implied a total of perhaps 700,000 homeowners seeking forbearance.

He said that number was likely to rise: “A lot of people got paid for half of March, so a lot of people who were able to make their payments in March won’t be able to make their May payment.”


Oil majors raise $32bn of debt to weather crisis

Brendon Moran, a senior energy banker at Société Générale said: “The playbook is the same as previous crises: those that can get out into the bond market are doing it. It secures liquidity but it also demonstrates that they have access to funding.”

Shell this week raised €3bn and $3.75bn, while BP tapped the market for €3.25bn and $3.25bn. Total and Equinor raised debt of €3bn and $5bn respectively. OMV of Austria raised €1.75bn. This followed a move by Exxon to raise $8.5bn a few weeks earlier.

For some companies, such as Shell and BP, the bond issuance comes on top of securing new multibillion-dollar credit facilities.

While some smaller companies and independent companies have already cut their dividend as they come under financial pressure, major energy groups are treating this as a last resort.

Many are aware that the payouts are one of the few reasons some investors hold the shares, as pressure builds on investors to move away from carbon-intensive industries.

Insolvency and restructuring firms brace for boom in custom

Lawyers, consultants and accountants get paid thousands of pounds an hour to solve UK plc’s biggest problems. Now they are in a quandary of their own. Faced with an unparalleled cash crunch, clients are pausing all non-essential spending. Dozens of deals have been mothballed. Nice-to-have projects have been put on ice.

But it hasn’t all been bad news for the City’s well-heeled professionals. The ultimate counter-cyclical business, insolvency and restructuring, is preparing for a boom.

“The diary is full of calls from half seven in the morning, and laptops are going down at midnight. You’re on calls relentlessly with directors and lenders. It has been very, very intense – very long hours and weekends,” says David Fleming, a debt and restructuring adviser at Duff & Phelps. “But the ironic thing is being in isolation means it feels like you’re always at work anyway now.”

For now, Fleming is advising companies on deferring tax payments, and talking through restructuring options with banks and clients.

“It’s not just about insolvency options. It’s what else they can do as a business to save money, preserve cash and capitalise on the government initiatives,” says Carl Jackson, managing partner at Quantuma. “I have no doubt that the rate of corporate failures will increase in this calendar year.”

In preparation, Quantuma’s corporate finance teams are being redeployed to work on restructuring and insolvency cases. Jackson also expects it to add 15pc to 20pc to its 250-strong staff to meet the increased demand for its services.

Despite the severe strain on businesses, the workload for restructuring experts is likely to increase further if firms actually start going bust in big numbers. That wave of insolvencies is likely to be triggered if businesses can’t access government loan schemes before cash runs out or when state support is withdrawn when the present lockdown comes to an end, particularly if consumers are reluctant to go out and spend money.

“For the next three months, my guess is that corporate failures won’t rise significantly,” says Jackson. “Once we come out of this – and I hope and am sure we will do – that is the time you will see a rise in insolvencies because, at that stage, my expectation is the Government will withdraw or reduce the scale of support, and many a business will have a starved balance sheet and won’t be able to fund ongoing trading.”

Restructuring teams are not the only ones that are busy. Others have been getting stuck into the small print of contracts. Companies want to understand whether they or their customers and suppliers can postpone or avoid their obligations to pay for or deliver goods and services.

“I have spent probably the last two weeks flat out giving advice on force majeure clauses,” says Julian Copeman, a litigation partner at Herbert Smith Freehills.

After an initial burst of work advising on the mechanics of holding annual general meetings remotely and other novel issues, corporate and transactional teams face the prospect of much of their work drying up as deal-making slumps.

“Given the likely uptick in insolvency, restructuring and disputes work, no doubt some corporate and transactional lawyers will seek to rebrand – as happened post financial crisis,” says Tracey Dovaston, a partner at Boies Schiller Flexner, a corporate law firm that counts Barclays, Goldman Sachs and Lloyd’s of London among its clients.

But at the same time as helping clients to cope with the fallout, advisers are having to change how they run their own firms. Even a surge in demand for some services can’t make up for the slump in mergers and a deluge of board diktats to suspend non-essential spending, including on expensive advisers.

Partners at legal and accounting firms, which tend to be owned by the partners who run them, are facing the prospect of their payouts being cut or delayed.

“You’ve got to start deferring them,” says a senior source at one accounting firm. “You’re going to have more bad debt. Some people are going to take longer to pay you. It’s a straightforward look across to the corporate world where people are cutting dividends. If that’s the right thing to do in the corporate world, it’s got to be the right thing to do in professional services.”

Allen & Overy, the Magic Circle law firm, is among the top City outfits to have already begun reducing partners’ profit distributions. Partners, who took home an average of £1.7m last year, have also been told to plough more capital into the business.

Norton Rose Fulbright, another City law firm, is also delaying payments to partners, replicating its survival strategy from the last crisis by asking staff on over £45,000 to switch to a four-day week, and take a 20pc pay cut. Lower paid staff will have their pay reduced on a sliding scale down to 5pc.

Rank-and-file lawyers at both firms have been told they won’t be getting pay rises in May, when City firms traditionally review rates. Norton Rose is also deferring its bonuses. Pay for corporate lawyers at leading firms has soared in recent years, with hundreds of newly qualified solicitors earning over £100,000 a year.

Consultants, accountants and auditors are also facing pay cuts or furloughing. Grant Thornton, the accounting firm with 4,500 employees, has asked staff to volunteer for hours and pay cuts of 40pc or take a three-month sabbatical on 30pc pay. Those who do not take up the offer could be furloughed on 80pc of their salary up to a maximum of £3,125 per month if there is not enough work for them to do.

Many firms will also have been banking on being able to increase billing rates. Hourly charge-out rates are reviewed by most law firms at the beginning of each summer. “This is not the market in which you would expect law firms to be upping their rates,” admits one senior lawyer.

At the same time as adapting to a darkening economic outlook, City firms have been grappling with running their entire operations remotely for the first time. While most had some degree of flexible working already – consultants have been working remotely from client offices for years – having everyone working from home has presented new challenges.

Moving at a :snail:'s pace no more

The rating agencies are still doing their jobs - just faster. They are quickly changing their models that forecast a bunch of companies’ abilities to repay what they owe on time and some people aren’t happy:

“It is shocking a lot of people,” said Hans Mikkelsen, a strategist at Bank of America. “We have been pushed into a recession at a speed we have never seen before. Everyone is scrambling. Rating agencies are downgrading companies in a matter of weeks when it would usually take months.”

A record $90bn of debt fell to junk status in March, according to Deutsche Bank analysts. BofA warns that the total for the year could reach $200bn.

Investors appear to be set for even higher tallies. At the end of last week, $360bn of triple B rated bonds, the lowest rung of investment grade, were trading with yields comparable to that of double B rated debt.

Finding buyers for fallen angels could be challenging. The $6.7tn investment-grade bond market is far larger than the $1.2tn high-yield bond market, as measured by indices produced by Ice Data Services.