In January of 2019, Mark Carney, the governor of the Bank of England, appeared before a House of Commons committee to discuss global threats to financial stability. At that time, the U.S. unemployment rate was below four per cent, the gross domestic product was growing steadily, and Donald Trump was busy boasting about “the greatest economy ever.” But, despite these favorable statistics, staffers at the bank had identified a potentially serious problem on the horizon: a rapid buildup of corporate debt, which was associated with a potentially alarming decline in lending standards. Carney compared what was happening in the corporate-debt markets to the subprime-mortgage boom that culminated in the great financial crisis of 2008 and 2009. Citing the rise of “covenant lite” loans that placed very few restrictions on corporate borrowers, Carney said, “The subprime analogy isn’t perfect, but it’s on the road to ‘no doc’ underwriting, which happened eleven years ago.”

Carney’s warning didn’t make a big splash in this country. On Wall Street, it was widely acknowledged that there had been some excesses in the corporate-debt market, and that credit standards had slipped. Decades ago, blue-chip corporations jealously guarded their top-notch credit ratings: they were wary of issuing too much debt. But, in a new era of finance-driven capitalism, companies like American Airlines, Hertz, and Staples borrowed heavily to finance acquisitions, stock buybacks, and, in some cases, leverage buyouts sponsored by private-equity companies. Between the fourth quarter of 2009 and the fourth quarter of 2019, the total debt of non-financial corporations rose from $6.1 trillion to $10.1 trillion, according to figures from the Federal Reserve Board.

Much of this new lending came in the form of issuing bonds, but newer forms of credit also proliferated. Between 2007 and 2019, the value of outstanding “leveraged loans,” which are syndicated loans extended to companies that credit agencies rate below investment-grade, rose from $554 billion to $1.2 trillion, according to S & P Global. In turn, many of these leveraged loans were used to create collateralized loan obligations, or C.L.O.s. These complex and opaque products are close cousins of C.D.O.s—collateralized debt obligations—which played a big role in the subprime boom and bust. In creating both C.D.O.s and C.L.O.s, financial alchemists on Wall Street took a pool of sub-investment-grade loans and sliced and diced them into various “tranches,” some of which were then given triple-A ratings and marketed to investors as a source of safe and regular yields. By the end of 2019, there was about seven hundred billion dollars’ worth of C.L.O.s in existence, according to industry estimates.

Many of these C.L.O.s are directly associated with private-equity partnerships, which benefitted in at least two ways from their growth. Corporations sponsored by private-equity companies often used leverage loans to finance buyouts of their stockholders at very high multiples of earnings and cash flow. Some leading private-equity companies also got involved in the business of organizing and managing the C.L.O.s, where many leveraged loans ended up. According to CreditFlux, a news service that covers C.L.O.s and credit funds, the Carlyle Group and GSO Capital Partners, a subsidiary of the Blackstone Group, are two of the three biggest C.L.O. managers. Apollo, Kohlberg Kravis Roberts, and CVC Partners are also prominent players. Given their ownership of many highly leveraged companies and their central role in the C.L.O. industry, private-equity firms obviously have a huge financial stake in preventing a debt blowup.

As long as the economy was doing well, the debate about the potential dangers of excessive corporate debt remained theoretical. With interest rates at low levels, most corporate lenders, even highly leveraged ones, didn’t have much trouble meeting their interest payments or rolling over their debts. Default rates remained low, and some policymakers assured themselves that, even if they rose, the financial system was strong enough to sustain any potential losses. “Business debt has clearly reached a level that should give businesses and investors reason to pause and reflect,” Jerome Powell, the chairman of the Federal Reserve, said, in a speech last May. “However, the parallels to the mortgage boom that led to the Global Financial Crisis are not fully convincing. Most importantly, the financial system today appears strong enough to handle potential business-sector losses, which was manifestly not the case a decade ago with subprime mortgages.”

In the second half of last year and the first two months of this year, the corporate-credit boom continued. In February alone, thirty billion dollars in C.L.O.s were issued. But, as the coronavirus spread and widespread shutdowns began, everything changed abruptly. As many corporations faced the prospect of a big fall in their revenues, lenders and investors in debt products reassessed the probability that these firms would be able to meet their financial obligations. Credit spreads, which are a market measure of risk, widened dramatically, and the most speculative parts of the corporate-debt markets practically seized up. Issuance of leveraged loans and C.L.O.s fell precipitously. Where previously highly indebted companies had been able to raise practically any amount of money against practically any collateral, they suddenly had great difficulty raising any.

“The leveraged-loan market was screaming-hot in January and February, and then, suddenly, in the course of a couple of weeks, everything froze up,” Will Caiger-Smith, who oversees coverage of leveraged finance at Debtwire, a financial-news and data service, told me. In February, about thirty billion dollars’ worth of C.L.O.s were issued. In March, the figure fell to three billion. (In April, it was four billion.) “Basically,” Caiger-Smith said, “the pandemic has put the breaks on new issuance.”

It has also pushed many highly indebted firms toward insolvency. Already, some well-known retailers, including J. Crew and Neiman Marcus, have filed for Chapter 11 bankruptcy protection from their creditors. (Both companies had loaded their balance sheets with debt in private-equity deals.) These highly publicized filings are just the most visible sign of the widespread distress in the more speculative regions of the credit markets. In April, there were eleven leveraged-loan defaults, which is “the most ever during a month, exceeding the previous record of 10 in October 2009,” a recent report from S & P Global noted. With “grim forward indicators thanks to the Covid-19 pandemic, market sources expect more defaults ahead,” the report went on. The credit-ratings agency has predicted that leveraged-loan defaults could hit ten per cent by the end of this year.

So far, at least, there hasn’t been a blowup in the C.L.O. market to match what happened to the C.D.O. market in 2007 and 2008. But, as the number of defaults rises and the ratings agencies issue downgrades for large numbers of the leveraged loans that got sliced and diced to go into the C.L.O.s, the pressures on these opaque vehicles are growing. In a recent interview with the Financial Times, Matthew Mish, a credit analyst at UBS, said, “CLOs and the loans underpinning them are ground zero in terms of the vulnerability of this crisis.”

If your recent financial reading has been confined to reports about the stock market, you won’t have heard much about corporate debt. Ever since March 23rd, when the Fed announced that it would use its “full range of authorities” to maintain “the flow of credit to American households and businesses,” many investors have been assuming that the threat of a serious debt crisis is behind us. And, as far as some parts of the credit markets go, that might be correct.

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