Phorgy Phynance

Archive for the ‘LBO’ Category

High yield pipeline gets its first real test

leave a comment »

Even before things in credit markets went completely haywire, there were technical concerns about the building pipeline of new high yield issues that were feeding into CLOs, which were in turn spurring the LBO boom. My own quantitative analysis had shown that high yield was particularly vulnerable going back to September 2006 (which my models were unfortunately only completed in March-April). That is why I was so certain that July 16 would be a big day. That was the day Bear Stearns was to report their hedge fund losses.

I think we all know what happened after that, but I still think not everyone is aware of the huge buildup of high yield issues that have resulted from delays as brokers “hope” things get better. This has created a bifurcation in the primary market (which is essentially non-existent) and the secondary market. Just as holding of CDOs will eventually be forced to face the music, the high yield market will need to face the music and eventually issue some new bonds. That will (in my opinion) bring in a pretty clear “mark to market” in high yield and there very well could be another general repricing.

Apparently, next week is the first real test as First Data issues $24B of debt ($16B in loans and $8B in bonds)

All Eyes Are On First Data
September 10, 2007

If I were a high yield investor (which I’m not, so don’t take my armchair analyst advice too seriously), I would not be eager to get back in just yet. I think things will still get worse before they get better, but like they say “only monkeys pick bottoms”, so I would certainly be shopping for bargains, while keeping in mind that the definition of a “bargain” has changed. For example, the assumption of continued historically low default rates should be discarded imho.


Written by Eric

September 9, 2007 at 12:34 pm

Party like it’s 1998… or 2001… or 1987… or 1929… or 1907

with 5 comments

What a week!! I certainly picked a good time to start a new job in structured finance. It’s only my first week and I’ve already had two 16 hour days where I was in the office until after midnight 😮

Actually, I love it! I love the intensity and love pushing myself. Reminds me of grad school 😉

Anyway, the big news from the Fed last week was the lowering of the discount rate. Over on NP, I voiced my opinion in a brief statement:

I think it is a smart move. The first sign that Bernanke isn’t as bad as Greenspan.

I thought it was an innocuous enough statement, but apparently Greenspan has a lot of fans out there. I was immediately greeted with:

[From RRP:]

Care to elaborate on this? I agree that boosting liquidity even modestly right now will be extremely helpful but I’m not sure that G-Span would have acted differently in this circumstance. Sure he was a bit compulsive about inflation but he gave the system liquidity when it really needed it. In 98 after Russia the discount window borrowing rate went from 5 to 4.50. Same magnitude move we are seeing here. You do realize that the target rate isn’t changing, the secured lending rate is?

[From FDAXHunter:]

I’d like to know what IAmEric is going on about as well. Greenspan was adamant about making sure that bubbles didn’t end up as complete disasters. He was well known to provide liquidity in times of crisis. So how is Bernanke better than Greenspan?

[From uranasss:]

I’d also like to hear IAE’s reasoning…

Then, I replied with what I thought was a reasonable succinct explanation:

Greenspan would have already cut the Fed rate by 1% (or more). That kind of behavior is what got us here. Cutting the discount rate while keeping the target rate at 5.25% makes sense. Nothing more nothing less.

This is where I think RRP got a little out of line, but hey, we are all adults, right? No biggie.

Please, don’t let facts get in the way of your hyperbole but a quick check would reveal this to be pretty much untrue. Taking 98 (which was worse than this crisis has been to this point) to be a good comp (an article of faith no doubt, but bear with me) we saw three rate cuts for a total of 75bps by mid november. This is a full 3 months after the default and two months after things started getting extremely nasty. Lo and behold target rates were back to pre crisis levels by mid November 99. It looks like an effective use of policy to get through a crisis to me.

Now you can fall into the camp that will blame the fed policy for the run-up in home prices and ultimately the housing bubble. That’s well and good, but cheap fed funds do not a bubble make. It takes a great deal of complacancy from the whole financial community to ignore the facts which are now so blindingly obvious and had been obvious to most people paying attention for the past 5 years. If you want to make a substantial loan to somebody and require less verification than it would take to get a Sears card be my guest, just don’t cry to me when you get hurt. There’s a lot of pain out there right now and there’s not a single fucking person feeling it who doesn’t deserve it. Idiotic borrowers, opportunistic originators, greedy investors, lax rating agencies, traders with tunnel vision, bankers with short time horizons, every last one of them is getting stomped (including yours truly). It’s their own goddamned fault so don’t put it at old Alan’s doorstep.

And for the record, I’m not in the camp that thinks Greenspan is one step removed from Jesus, I just belive he performed more than adequately in an extremely difficult job.

I’m really not sure what kind of logic it takes to look at the historical funds rate as evidence against my “opinion” that Greenspan would have already dropped rates by a “1% (or more)” in the last 5 months. I replied with:

You are certainly entitled to your opinion. I hope it has served you well. Comparing this to 1998 may be justified, maybe not. I think not.

The data you yourself supplied shows 8 – 50 bp drops and 3 – 25 bps drops in 2001 alone. ABX tanked in Feb-March. I think Greenspan would have thrown in a few 50 basis pointers during the last 5 months. It’s just my opinion and as we all know, that is what this entire industry is built on, i.e. art versus science.

Then energetic chimed in with…

I think Greenspan would have thrown in a few 50 basis pointers during the last 5 months.

Eric, dude … Head against Wall

I could only afford one last comment before being buried in modeling…

Look at the data man! If anyone should be frustrated, it should be me. I don’t blame people for talking their books though.

Edit: Here is the data for 2001


December 11 – Rate cut 25 bps to 1.75
November 6 – Rate cut 50 bps to 2.00
October 2 – Rate cut 50 bps to 2.50
September 17 – Rate cut 50 bps to 3.00
August 21 – Rate cut 25 bps to 3.50
June 27 – Rate cut 25 bps to 3.75
May 15 – Rate cut 50 bps to 4.00
April 18 – Rate cut 50 bps to 4.50
March 20 – Rate cut 50 bps to 5.00
January 31 – Rate cut 50 bps to 5.50
January 3 – Rate cut 50 bps to 6.00

RRP chose to argue against a Greenspan “1% (or more)” rate cut by pointing at 1998 (as if today somehow resembles 1998). Using similar logic (which admittedly isn’t very sound), I pointed at 2001. That is not to say I think today’s environment resembles 2001, but was simply meant to point out that the Fed Greenspan could have a lead foot when it comes to rate cuts in times of “crisis”, which I think current events count as.

Then the fun started:

[From energetic:]

So, you want to compare the current crisis with the aftermath of .com collapse? AFAIC, this is a bad model, but you would agree, would you not, that there was a considerable delay in Fed reaction even then?

[From kubrick:]

IAE, regarding 2001, comon man… that was a recession with 9/11 thrown on top to boot. Where is the comparison?

[From RRP: (my emphasis in bold)]

It were not best that we should all think alike; it is difference of opinion that makes horse races” – Twain

And I tend to agree with him. But seriously, this is not some random trash bin on the internet where anyone can say whatever pops into their head and not have to defend it.

So in the spirit of fairness here is whyI think that this is more similar to 98 than not (and coincidentally 98% of the people I’ve spoken to on this are in agreement).

  • Seemingly isolated events torching unrelated markets
  • Deals ground to a halt
  • Media panic about shadowy hedge funds toppling the global financial markets
  • Decrying the fed bail out that has yet to materialize
  • The feeling that there is no end in sight
  • Summer totally getting fucked; My drinking is purely therapeutic at this point and not for recreation

Please let me know why you don’t think it’s similar. And just an aside in my youth, some really old dudes informed me that everyone thinks the first market crisis they experience is really new new new when in fact history repeats itself more than we’d like to admit. It’s just better sales to say we’ve never seen anything like this before, making the same mistake twice appears really really dumb for some reason.

As for 2001 and this being similar, or similar enough to compare fed reactions, please elaborate. Seriously, people got what the hell was going on there, equity markets were getting trounced on the heels of the dot com shutdown but fixed income was in fine shape. Business investment dried up very quickly. This whole irrational exuberance drum was getting pounded before the equities collapse(Greenspan 96). Again, not that it matters if you are ultimately right, because if you miss out on the way up you’re not going to keep your job long enough to be vindicated. Also to the point 2001 was a reaction to fundamental economics, 98 was a reaction to a crisis in confidence. Two different animals in my book. Sir Appleby, I don’t necessarily disagree with you on the Drexel thing but 91 was really a recession as well and I think trying to separate the fed motives for liquidity provision vs. managing targets for key economic variables is a little tougher task. Plus I was just getting pubes in 91 so I don’t have a lot of knowledge of it.

The problem I have with second guessers is that they generally are the last to the party and the first to point out how shitty it is. It’s easy to criticize and hard to create, I mean really are you really disappointed with the Greenspan track record en total from 87 to 06? What would you have done differently? Why do you think things would have turned out better?

Wow. What can I say? That is just real %$#^ed up. To be fair, RRP is probably sitting on a portfolio of CDOs and is understandly not in such a great mood these days (even though I did warn him long ago) 😉

It didn’t end there though. Tabris, ironically speaking of jumping on band wagons, had this to say:

Now with regards to the Fed discount rate, we can all speculate on what G-span would have done (my bet on 25bps cut next meeting if G-span still in office) but it is really a moot point. The fact is, Big Ben is beginning to realise the issue they are having in liquidity and is taking pre-cautionary steps in correcting the LIQUIDITY problem. They are not bailing out HFs or mortgage clowns as HFs will still blow up and Mortgage clowns still have to sit on their bed of toxic subprime loans. Nothing more, nothing less…

Now, less bandwagon jumping, and more evident based debate please.

RRP, you have my respect for being one of the few guys trying to bring this debate back from the pits. Drinks on me next time! Chug Beer

Then, last night before hitting the sack after a very long week, I posted the following:

Why is this not like 1998? In 1998, it was a “liquidity” event. As such, pumping liquidity into the markets does make a certain amount of sense. What is unfolding now is a combination of “liquidity event” with a bursting “credit bubble”. It is not a “mortgage” issue that has spread. Rather, it is a general “fixed income bubble” that is bursting. THAT is different and that will not be made better by pumping the system with liquidity. You can argue all you want (and you’re certainly entitled to) that the Fed had nothing to do with inflating the credit bubble since 2000-2001. You’d be in good company. Conversely, if you thought the Fed’s policies encouraged the credit bubble, you’d also be in good company.

That is the kind of conversation that can be potentially interesting. One where you have super sharp and experienced people on both sides of the aisle with completely opposite views on things. As I’ve said before, I subscribe to the concept of “economic Darwinism” and that a recession now and then is a good thing for long term growth. I am in good company on that one. I particularly enjoyed Andy Xie’s recent piece:

Market Insight: Time to end central bank bailouts of markets

If central banks try to bail out Wall Street, it would lead to high inflation for years. The inflationary effect of loose monetary policy of the past was offset by the deflationary effect of globalisation. Now China and other developing countries are experiencing high and rising inflation. Loose money will go straight into inflation. The vicious cycle of the wage-price spiral of the 1970s has not occurred as both labour and capital still believe in the inflation- fighting credibility of the central banks. If they loosen up again to bail out Wall Street, this credibility may be squandered. The ensuing wage-price spiral could ruin the global economy for years to come.

What is occurring is an opportunity for central banks to restore their credibility. Markets have been taking more risk than they should because they believe that central banks will come to their aid during times of crisis, like now. The penchant of Alan Greenspan, former US Federal Reserve chairman, to flood the market with liquidity during financial instability is the genesis of this “central bank put”. As long as this expectation remains, financial bubbles will occur again and again. Now is the time to act. Let the crooks go bankrupt. Central banks should bury the Greenspan “put” for good.

Band wagon? There certainly may be a lot of that going on these days, but I hope you don’t put me in that category. Just read what I’ve said over the last couple of months. Private equity? LBOs? CLOs? Structured finance in general? High yield? Those might be headlines now, but they certainly weren’t back when I first began blabbering about them (Maybe it was incoherent blabbering, but blabbering all the same). The first time I began publicly voicing my opinion about Bernanke and Greenspan was on July 3 in the “Liquidity Liquidity Everywhere” thread (and no, I am not running around in glee Puke ).

Greenspan and Bernanke are both wankers. I call it “forest fire monetary policy” (there is probably a better academic name). It is better to let the forest burn once in a while in a controlled blaze then to let timber build up over years and years. That situation can only end in inferno.

Believe me, I had been arguing with economists and other analysts about the point far earlier than that. [Sidenote: If you are a noob to monetary policy, but would like to a know a bit about what its all about, I highly recommend A Term at the Fed.] Not that any of that matters, I just felt like debunking the “band wagon” statement, which is a bit like setting up a straw man, don’t you think?

And I’m certainly not criticizing in bad times and chearleading in good. I’ve been warning anybody who would listen about CDOs since the moment I learned about them (and have the well-received research reports to prove it). And now that the sheah has hit the fan, I’ve joined a structured finance group. One reason being that I know there are some great opportunities and working through this time will be a killer learning experience. Having said that, I still wouldn’t touch a CDO with a 10 foot pole, but there is more to structured finance than toxic voodoo magic.


Anyway, it seems that jumping on “IAmEric” has become an increasingly popular recreation sport on NP these days, and since I value the community there, I still want to avoid senseless rants or jibes against my comments which just distracts from the conversation (and decreases the likelihood of having an actual valuable contribution from kr or Bachelier etc). So… I recreated the relevant parts of the conversation here. Have at it! That is what blogs are for. Give me what you got 😉

Written by Eric

August 18, 2007 at 7:31 am

Non-Leveraged M&As versus LBOs

with one comment

Here is something I posted to NP back on July 24:

[From rrp:] I guess the point is that credit spreads are out and this validates your belief that HY Credit spreads are in trouble and ergo private equity is in trouble. I am not sure this is the case. Credit spreads are just one function of how a transaction is going to look.

Hi rrp,

I think the link between HY and private equity is via the CLO market. Spreads widening in HY will make getting CLOs done more difficult. That marks the end of LBO activity and trouble for private equity.

From someone sitting on the sidelines, it seems pretty clear that private equity is about to eat it. Keep in mind that I’m currently on “garden leave” and am sitting in front of my computer (in my boxers… too much information?) reading finance blogs, watching BBG online TV, and reading web news all day. Kind of artificial knowledge, but so far I think I’m getting decent information. For example, here is an article that enunciates the CLO thing more clearly than I could:

After price spike, debt market pros see calm before the storm in corporate leveraged loans

Here’s the chain I’m currently contemplating:

subprime CDO imploding -> HY repricing -> CLO slowing -> LBO stopping -> private equity choking -> equities tanking -> M&A increasing -> ???

I’m also watching petrodollars migrating away from USD, e.g. Iran forcing Japan to purchase oil in Yen, Russia paying in Rubles, parts of Europe paying in EUR. Oil bourse? Not to mention sovereign reserves diversifying away from USD.

I want to buy gold…

PS: I’m blabbering in an attempt to maximize the learning experience from watching the events unfold. I hope I’m not irritating the pros Beer

Edit: Updated icon.

Edit^2: Plus, you gotta love Bill Gross.

Enough is Enough

Edit^3: Speaking of petrodollars migrating away from USD…this just appeared…

Kuwait Strengthens Dinar for Second Time as Dollar Weakens

In general, I love the guys at NP. Super smart and surprisingly patient with the likes of me. However, it’s becoming clear that I’ve developed a few vocal (and some not-so-vocal) critics over there. That doesn’t bother me too much. The only way to go through life and not have critics is to not have any opinions. Once you voice your opinion on something people feel strongly about, you’re bound to step on a few nerves. So be it.

Since I do value the community there, i.e. I even admire my critics, I’ll probably express my opinions here rather than there for a while. At least until the current bloodbath in the markets is over (which I don’t think will be any time soon). The latest criticisms are so irrational that I don’t even know how to respond, so I won’t. Not there anyway. I’ll just assume that people are particularly grumpy because they must be on the wrong side of the credit markets and seeing their bonuses disappear, which certainly isn’t my fault.

But regarding that quote above from my last post, there is something I wanted to clarify. Particular the chain of events that I outlined, i.e.

subprime CDO imploding -> HY repricing -> CLO slowing -> LBO stopping -> private equity choking -> equities tanking -> M&A increasing -> ???

At the time I wrote that, we were only on step two, i.e. subprime had imploded and HY had repriced (a bit). I think their is still long way down to go for credit, but at the time I wrote that CLOs hadn’t been hit yet, LBOs were not on the radar screen (of most anyway), and the idea that private equity was in trouble seemed ludicrous. How about now?

Now, everything has occurred except “M&A increasing”. At the time I wrote that I was distinguishing LBOs from M&A, but have since learned that many people include LBOs under the M&A umbrella, so I thought I would clarify what I meant by that last item before the “???”.

LBO activity was driven by (at least) two factors: easy credit and value in acquiring companies. The first factor is now gone, which is why private equity is hurting. The second factor remains. Easy credit made it difficult for real-money people to take advantage of the value in acquiring companies because of competition from private equity. With easy credit gone and private equity struggling to get LBOs done, now people/corporations with real money on hand can take advantage of the situation.

By “M&A increasing” I meant that mergers and acquisitions that are not dependent on leverage, i.e. by people/corporations with “real money”, would increase. This, I thought, would prop up equities for a while longer. For example, on July 25, I said:

Since I expect LBO activiate to be significantly hampered, if not halted, and since there is value in stripping some of the companies, I expect more M&A activity to replace LBO activity.

I meant “non-leveraged” M&A. So watch for this. The first sign of this happening that I’ve seen comes from Bloomberg in regard to Warren Buffett. Certainly a “real money” guy.

Buffett’s $46 Billion in Cash Could Buy Kohl’s, Nucor

Here’s an excerpt:

Berkshire Hathaway Inc. Chairman Warren Buffett is ready to spend $40 billion to $60 billion on an acquisition, and his opportunities are expanding as stocks fall and leveraged buyouts dry up.

Shares of health insurers, steelmakers and department stores are as much as 22 percent cheaper than in May, when Buffett said he would “figure out a way” to come up with $60 billion for the right deal. WellPoint Inc., Nucor Corp., Kohl’s Corp. and dozens more companies are now closer to meeting his investment criteria.

Written by Eric

August 5, 2007 at 9:39 am

Posted in LBO, M&A