🌧What to Make of the Credit Cycle🌧

Sears Holding Corp, National Wholesale Liquidators

Disruption from the Vantage Point of the Disrupted
Member Briefing #31 - 10/28/18
Read Time = 20 a$$-kicking minutes
Twitter: @petition
Website: petition.substack.com


Several of you have reached out asking us for a compendium of information about “the cycle” and we thought there’d be no better way to do that than to aggregate our ongoing “What to Make of the Credit Cycle” series — some of which has been released in freemium editions and others in Members’-only editions. Here, for your ease of reference, is the entire series to date. We hope you find this useful. Cheers!

🗞News of the Week (2 Reads)🗞

1. Sears: How the Sausage is Made (Long UCC Shenanigans)

TL; DR: This thread.

The funny thing about the bankruptcy business is that, unlike most businesses, it isn’t quite ripe for recurring revenue. Think about it. Tax lawyers generally maintain a long-lasting fundamental relationship with a client that can last decades if a business is viable and growing. M&A lawyers that effectuate a solid buyside rep will generally have an opportunity for the next tack-on acquisition. If they do the sell side rep, perhaps they’ll impress the buyer with their pragmatism, showmanship and bromanship to sideswipe the incumbent banker and become the first call for the now-larger enterprise’s next transaction. As a financial advisor, a firm may do a performance improvement project which, after an acquisition and a need for integration and synergy realization, turns into a second bite at the PI apple later on. Or, perhaps all hell will break loose, PI is no longer an option and the PI guys can transition the client to the restructuring advisory team. All told, generally speaking, there are at least colorable avenues for repeat business if you’re in one of those positions.

Not so much for debtor lawyers. The company-side bankruptcy business is unique in that way because it’s not typically a business that throws off recurring revenue (corporate work be damned). If it does, that’s another issue that calls into question the advice and/or structure of the first deal. But as much as we like to snark about Chapter 22s, they are generally rare and it’s even rarer for a company to hire the same cadre of professionals in repeated go-arounds (mostly, quite obviously, because the new owners have their own go-to bros to hire…though, there are exceptions, e.g., Radio Shack/General Wireless). And, so, unfortunately, there is virtually every incentive to run up fees like a bawse. Not that all do, but let’s just say that there isn’t much dis-incentive. Just saying.

Now, sometimes this could backfire. There was a ton of management level turnover during the oil and gas downturn and so CFO Mr. Frack Happy at Company Midland PUD that went bankrupt in 2015 might show up as the CEO of Company OK Earthquake in 2016. Imagine what happens if you milked Midland PUD for a few million in fees and then Company OK Earthquake starts triggering your “screens” a year later. You ask some junior associate to review contacts at the C-suite level and she flags Mr. Happy. Upon seeing that and unleashing a dramatic carton-style “gulp,” you probably aren’t Mr. Happy Biglaw Partner yourself. In fact, you are probably more like Mr. Oh F*ck. This is rare, but it happens.

Yet, creditor side bankruptcy lawyers don’t suffer from this problem. As the big funds get bigger and bigger, it’s getting increasingly easier for a law firm to cover the universe of large distressed hedge funds, build relationships over time, and then dominate the ad hoc committee space. Akin, Paul Weiss, Davis Polk and Milbank, among a few other firms, are doing very well there.

And then there are the committee practices. Recurring business here is no problem at all. Just look at how many committees certain REITs have been on amidst the #retailapocalypse. Countless. And so being buddy-buddy with their main workout guy and/or the indenture trustee reps is a sure-fire way of securing recurring work. And by “buddy-buddy,” we mean picking them up in private jets en route to some fancy golf tournament or leaving a mysterious wad of cash on their doorstep. You know, totally kosher sh*t.

The best part of this whole buddy-buddy thing is that it is so much harder for lawyers than it is the numbers guys. Ethical restraints make it difficult for the law firms to reach out and be buddy-buddy directly and so most law firms have financial beards that do their bidding for them. These beards can grease the skids for weeks if not months in advance of a filing. We wonder how many FA-sponsored boondoggles to blow sh*t up in Vegas conveniently happened to have mass attendance by their go-to law firm partner on the last 4, 5, 6 or 7 UCC committee gigs? We are betting that number is not 0.

Wait. Weeks? Months? You betcha. These guys have it down to a science. Most indentures are out there. Most key vendors are easy to trace. They can easily figure out who may be in the top 20 creditor list. And if you are late to the game, perhaps the company-side FA will be so kind as to leak you a draft in advance of the filing so that you — and not the ahole from the last deal — have a better shot of lining up your ducks and being on the other side of the table.

Because let’s be honest: most committee pitches are won before the professionals even enter the room. For instance, take Sears Holding Corp. ($SHLD). Do we all really think that the members of the committee have the attention span to earnestly listen to...hang on...one (Akin)...two (Cooley)...three (Foley)...four (Kramer Levin)...five (MoFo)...six (Pachulski)...seven (Proskauer)...eight (Quinn Emmanuel)...nine (Sullivan & Cromwell)...pitches in one afternoon?! C’mon. That was a two-horse race before the doors even opened. Talk about acts of futility.

It’s only after the horses have triangulated, relationship-wise, the members of the committee, that performance actually enters the equation and the pitches matter. That’s when case precedent can come into play.

Look, Sears is a bit of a special case. It has been a slow moving train wreck for years. Everyone has known that it was coming. This presents the perfect opportunity to set yourself up both in terms of relationships and quals/performance. And so when you’re down to two firms and you know that there are significant pockets of value that are subject to attack in ways that could potentially enhance unsecured creditor recoveries, do you choose the firm that talked a big game about alleged independent directors and div recaps only to settle (Payless Shoesource) or do you choose the firm that is digging in its heals and is bulldogging through a case against a powerful PE firm, it’s powerful lawyers and its pervasive directors (Nine West)? Sh*******t. Nine West is the undercard. Sears is the main event.

And so Akin Gump Strauss Hauer & Feld LLP has nailed down the UCC legal role. Sure they’ll throw 651 partners and 1 associate on the mandate and bill $46.8mm to prepare fee apps, but at least there’s good reason to suspect that they’ll be going for ESL’s jugular. And, here, there’s even less reason to care about whether they’re running up the fees. The estate and ESL are basically synonymous and so there’s some sick poetry in financing the efforts with the besieged’s own dollars.

God bankruptcy is beautiful.


Speaking of the Sears UCC, we found David Simon’s commentary on his recent earnings call pretty interesting. Michael Bilerman from Citigroup Global Markets Inc. asked him to comment on the UCC appointment and SPG’s exposure to Sears. Here was the answer (from SeekingAlpha):

Look, I think the thing to focus on, we're putting Sears in our rearview mirror. Okay? So what we're trying to explain – and there are a lot of moving boxes and obviously, the whole situation is a tragic, frankly. Put aside, how it affects us, we think this is a unique opportunity. We're going to redevelop this. We're going to generate positive momentum with the properties due to this. We're going to reinvest in the communities. We're going to be able to drive traffic now from this box. Put all of that aside, we're going to be able to make money on this. Put that all aside, if I may, and just it's a tragic set of events that a company that's been around for so long is in this state of affairs. So that to us is – that's what I think about. It wasn't that long ago, 10, 12 years ago, that 300,000 people worked at Sears. Okay?

So I mean, I think we should put that in perspective. But let's focus on what we – the task at hand. And what I'm trying to do – and there are a lot of moving parts, but basically – and what I explained – I'm sure I garbled some because you know I have a hard time spitting out words. But the reality is, we have 33 stores that are closed or in the process of closed at the end of this year. We control 22 of those and 5 of those are in our joint venture with Seritage. Of the 17 that we have unmitigated control, Sears will no longer exist in 2019. They will either be torn down, redeveloped, re-leased, but they'll be in our rearview mirror. So we are effectively down to 29 operating stores. We own 8, Seritage owns 4, and then the 17 are owned by Sears. And we'll have to wait and see what happens on the – in terms of whether they'll continue to operate those or not. Obviously, we're planning for the ultimate unfortunate demise of Sears and we're ready for it. And we have the balance sheet and the capital with intellectual and human resources to deal with these set of events.

So, that's what I would focus on. The other thing to keep in mind is that there's also Seritage that owns some in that. And they've done a reasonable job of re-leasing some of their space. So those are the numbers that I would focus on. And it's still moving around because they – some are closed, some aren't, but those are the numbers. And at the end of the day, next year, we'll report 29 Sears stores. That's it.

Speaking of incentives, it strikes us as a wee bit odd that there is a member sitting on the UCC that has unabashedly indicated that it wants to be done with Sears and that it will stand to make money if Sears outright disappears. Query: does this make them representative of the various other general unsecured creditors with supplier or employee relationships with the bigbox retailer? 🤔

2. New Chapter 11 Filing - National Wholesale Liquidators

“So Much…For So Little” is an apt motto for a company that is now in bankruptcy court.

New York-based National Wholesale Liquidators is a chain of 11 general merchandise close-out stores located in urban and surburban parts of Massachusetts, New Jersey, New York and Pennsylvania. The company has 695 employees and a severe liquidity problem. Due to construction problems that hampered one of the most profitable locations and a bungled roll-out of a new store — coupled, of course, with macro factors attendant to operating brick-and-mortar retail today — the company has effectively lost access to its $22.5mm Capital One credit line and its ability to maintain inventory.

Consequently, the company has been attempting a sale process to no avail. While the company hopes to continue to pursue a sale in bankruptcy, it is also moving forward with a store closing process with Hilco Merchant Resources LLC and Gordon Brothers Retail Partners LLC that, sadly, may have the effect of putting 695 retail workers out of jobs.

And so while certain retailers appear — at least based on last quarter’s public earnings — to be turning some kind of corner, it’s obvious that there is still a lot of pain in the B&M retail space. Certain commentators have opined that the #retailapocalypse is over. Spoiler alert: it’s not. And those commentators are smoking some high quality crack.

💥Compendium: What to Make of the Credit Cycle💥

1. What to Make of the Credit Cycle (Part 1)(April 8, 2018)

Earlier this week, Moody’s Default and Ratings Analytics team forecasted that the US’ trailing 12-month high-yield default rate will sink to 2% — from its February 2018 3.6% level — by February 2019. That is not a good sign for restructuring professionals itching for an uptick in activity.

FitchRatings chimed in as well, noting that underwriting standards underscore that the leveraged debt market is in the later stages of the credit cycle. But, it added,

“Aggressive documentation terms now prevalent could challenge recoveries in the next downturn. However, a surge in refinancing activity since 2016 should increase time between the credit cycle's bottom and peak in default rates. Looser documentation, such as the prevalence of covenant-lite (cov-lite) loans, should also lower the risk of technical default while enabling issuers to access additional funding via secured debt and unrestricted subsidiary provisions.” (emphasis ours)

You don’t say, Fitch.

But what about leveraged loans? Fitch notes,

“Cov-lite loans account for almost 80% of U.S. institutional loan issuance today versus just 25% at the credit cycle peak before the last recession. A supply/demand imbalance in the market has increasingly enabled issuer-friendly terms, which point to an imbalance between investor risk and reward indicative of being in the late-stage of the credit cycle. Such terms can include documentation allowing a borrower to incur additional leverage leading to credit profile deterioration, deterioration of collateral protections, reduced pricing protection and terms that affect lenders' ability to assign their allocation (i.e. trading liquidity).

The credit cycle peak is typically followed by a downturn, where financial conditions deteriorate and, eventually, default rates rise. However, issuers have secured large cushions that should prolong this process. The likelihood of technical defaults resulting from failure to comply with covenants should also be lower owing to the rise of cov-lite debt in recent years.” 

Will be interesting to see what impacts FED rate increases, Tax Reform, and tariffs will have on this assessment. Now recall that Guggenheim Partners cautioned that a recession is likely in late 2019 or early 2020. This week, Scott Minerd, the firm’s “head of investing” doubled down (video). He indicated that once short-term rates hit 3%, that will be enough to drive up defaults. He notes,

"As interest rates keep ratcheting higher, with record levels of corporate debt it's going to be harder and harder to service…at some point, as the economy starts to mature and as cash flows start to stabilize and decline, it's going to be difficult for everybody to pay this interest."

Or as Frank K. Martin notes“[e]very Fed tightening cycle eventually exposes and leads to the collapse of the bubbles de jure.” He notes that the corporate-debt-to-GDP ratio today mirrors that of three prior credit cycle peaks:

There’s too much in the succinct piece to summarize here: we strongly advise you to just read it. Indeed, bond investors seem to be taking notice: borrowers are actually having to cave on terms of late. Indeed, banks looking to syndicate the $1.02 billion loan backing the buyout of US greeting cards and stationary maker American Greetings by Clayton Dubilier & Rice (CD&R) look like they may be stuck holding the bag. From Reuters,

“The deal struggled to gain momentum in syndication after investors shied away from buying debt in a company facing uncertainty….”

Discipline in the capital markets? How quickly the tide turns.


On the flip side, there is so much money out there that that, too, could help stave off defaults: BDCs are now able, through President Trump’s “Consolidated Appropriations Act of 2018,” to incur significantly more debt and, per the Wall Street Journalprivate vehicles raised $2.4 trillion in capital last year — just in the U.S. Indeed, GSO Capital Partners has closed on a $7 billion rescue-lending fund. And JPMorgan Asset Management seeks to raise a new $250 million special situations fundBill Ackman is also looking to…oh, wait.

Any which way you slice it, it looks like the chessboard is getting set up for an interesting 2019/2020.

2. What to Make of the Credit Cycle (Part 2)(April 11, 2018)

In Sunday’s “What to Make of the Credit Cycle (Part 1),” we noted various takes on the credit cycle by Moody’s, FitchGuggenheim Partners and Frank K. Martin. In his letter to shareholdersJPMorgan ($JPM) CEO Jamie Dimon chimes in and offers a similar conclusion to that of Guggenheim Partners’ Scott Minerd. That is: there’s a good chance that interest rates will go up faster than expected. And that will have ramifications. Here’s what he had to say,

“Since QE has never been done on this scale and we don’t completely know the myriad effects it has had on asset prices, confidence, capital expenditures and other factors, we cannot possibly know all of the effects of its reversal. We have to deal with the possibility that at one point, the Federal Reserve and other central banks may have to take more drastic action than they currently anticipate – reacting to the markets, not guiding the markets. A simple scenario under which this could happen is if inflation and wages grow more than people expect. I believe that many people underestimate the possibility of higher inflation and wages, which means they might be underestimating the chance that the Federal Reserve may have to raise rates faster than we all think.”

He continues,

“If growth in America is accelerating, which it seems to be, and any remaining slack in the labor markets is disappearing – and wages start going up, as do commodity prices – then it is not an unreasonable possibility that inflation could go higher than people might expect. As a result, the Federal Reserve will also need to raise rates faster and higher than people might expect. In this case, markets will get more volatile as all asset prices adjust to a new and maybe not-so-positive environment.”

There’s a whole industry of restructuring professionals…gulp…hoping that he’s correct. There are a number of funds raising cash right now hoping that he’s correct.


Still, it’s a question of how much how fast. Wells Fargo ($WFC) yesterday indicated that a 300 bps increase in LIBOR would not immediately pressure most issuer’s capital structures. Also:

So. Yeah.

3. What to Make of the Credit Cycle (Part 3)(April 15, 2018)

Let’s be clear: NOBODY knows what the hell will happen with the economy. The prevailing view does tend to lean towards a recession somewhere in late 2019 or early 2020. Jamie Dimon, for instance, seemed to share this view, taking the position that the FED may need to raise interest rates faster than the market has priced in to date and that is a very likely recessionary catalyst.

Others, though, think he’s smoking crack. Well known finance blogger, Kevin Muir, for instance, writes (about Dimon),

“…what I find amusing is his belief that the Federal Reserve might have to take ‘drastic action’ raising rates due to inflation. I have no doubt that Jamie is sincere in his belief that inflation might take off, and that this will put the Federal Reserve in a terrible bind. However I take issue with his forecast that the Federal Reserve will step up to the plate and raise rates as quickly as Jamie foresees."

The reason for my skepticism? The debt distribution profile of the US government.”

This is a really interesting point. Take a look at this chart:

A meaningful percentage of the trillions of total debt on the FED’s balance sheet mature in the next five years. And US Federal debt translates to 104% of GDP.

He continues,

“So let’s recap. The total amount of debt is as large as it has ever been, while the vast majority of it is borrowed at the short end of the curve. Yet Dimon thinks the Fed will take “drastic action” and raise rates aggressively in the face of higher inflation?

All I can say is, sold to you Jamie. If inflation takes off, the Federal Reserve will face incredible pressure to not raise rates as quickly as monetary historians like Jamie Dimon recommend. It will simply be too painful. It’s not going to happen.”

It’s an interesting point. And it raises an interesting conundrum: if the FED cannot raise rates to combat inflation…what then?

4. Chart(s) of the Week - What to Make of the Credit Cycle (Part 3.1)(April 22, 2018)

Macquarie predicts an inverted yield curve in July 2019. An inverted 2-10 yield curve is generally viewed as a leading indicator of recession. Only, Macquarie, here, seems to be on the side of “Recession 2021,” which, as based on what we’ve noted in Parts 1 and 2, would be an outlier.

Kevin Muir notes,

Although we are miles away from being inverted as the front part of the curve is still relatively steep, the market is sending signals that the end of the tightening cycle might be in sight.

Eventually, at one the FOMC meetings, the Federal Reserve will raise rates and everything but the short-end of the yield curve will rally. At that point, the Federal Reserve will have hiked rates into the next recession.

And make no mistake. The market will know before any Federal Reserve official. There is no better signal than the yield curve. (emphasis his)

Also this:

5. What to Make of the Credit Cycle (Part 4)(April 25, 2018)

We’ve spent a considerable amount of space discussing what to make of the credit cycle. Our intent is to give professionals a well-rounded view of what to expect now that we’re in year 8/9 of a bull market.

Interestingly, certain investors have become impatient and apparently thrown in the towel. Is late 2019 or early 2020 too far afield to continue pretending to deploy a distressed investing strategy? Or are LPs anxious and pulling funds from underperforming or underinvested hedge funds? Is the opportunity set too small - crap retail and specialized oil and gas - for players to be active? Are asset values too high? Are high yield bonds priced too high? All valid questions (feel free to write in and let us know what we’re missing: petition@petition11.com).

In any event, The Wall Street Journal highlights:

A number of distressed-debt hedge funds are abandoning traditional loan-to-own strategies after years of low interest rates resulted in meager returns for investors. Some are even investing in equities.

PETITION Note: funny, last we checked an index fund doesn’t charge 2 and 20.

The WSJ continues,

BlueMountain Capital Management LLC and Arrowgrass Capital Partners LLP are some of the bigger funds that have shifted away from this niche-investing strategy. And lots of smaller funds have closed shop.

A number of smaller distressed-debt investors have closed down, including Panning Capital Management, Reef Road Capital and Hutchin Hill Capital.

PETITION Note: the WSJ failed to include TCW Group’s distressed asset fund. What? Too soon?

We should note, however, that there are several other platforms that are raising (or have raised) money for new distressed and/or special situations, e.g., GSO and Knighthead Capital Management.

Still is the WSJ-reported capitulation a leading indicator of increased distressed activity to come? Owl Creek Asset Management LP seems to think so. The WSJ writes,

Owl Creek founder Jeffrey Altman, however, believes that if funds are shutting down and moving away from classic loan-to-own strategies then a big wave of restructuring is around the corner. “If anything, value players leaving credit makes me feel more confident that the extended run-up credit markets have been enjoying may finally be ending,” Mr. Altman said.

One’s loss is another’s opportunity.


Speaking of leading indicators(?) and opportunity, clearly there are some entrepreneurial (or masochistic?) investors who are prepping for increased distressed activity. In December, The Carlyle Group ($CG), via its Carlyle Strategic Partners IV L.P. fund, announced a strategic investment in Prime Clerk LLC, a claims and noticing administrator based in New York (more on Prime Clerk below). Terms were not disclosed — though sources tell us that the terms were rich. Paul Weiss Rifkind & Wharton LLP served as legal counsel and Centerview Partners as the investment banker on the transaction.

On April 19th, Omni Management Group announced that existing management had teamed up with Marc Beillinson and affiliates of the Beilinson Advisory Group (Mark Murphy and Rick Kapko) to purchase Omni Management Group from Rust Consulting. Terms were not disclosed here either. We can’t imagine the terms here were as robust as those above given the market share differential.

The point is: some opportunistic folk sure seem to think that there’s another cycle coming. And they’re putting their money where their mouth is, thinking that there will be money to be made in the (seemingly saturated) case administration business. Time will tell.

6. What to Make of the Credit Cycle (Part 5): Moelis & Company Pounds Chest (April 25, 2018)

In the meantime, those who can leverage robust M&A activity will. But let’s take a step back…

Do you remember THAT scene in the “Wolf of Wall Street?” The one where Leo and Matty-C pound their chests in the most bro-ey of bro-ey banker moments…? We’re pretty sure this is what the bankers over at Moelis & Company ($MO) were doing before, after and as they were announcing earnings on Monday.

Take this quote for instance:

Analyst: “Ken, I still get plenty of investors that mispronounce the name of your firm, so I guess we’re still working on it.”

Ken Moelis: “There is no mispronunciation, there’s only a wrong phone number. If they get the phone number right….”

Kind of hard to argue with that. Who gives a crap how your name is pronounced if the phone is ringing, the rates are increasing and the dollars are coming in? Marlo Stanfield’s “My name is my name” proclamation in the final season of The Wire clearly doesn’t apply to Ken Moelis. Have to admire that.

So, right after we gave Evercore ($EVR)(which reports earnings today) and PJT Partners ($PJT) props in our Q1 review of bankers (to be fair: covering company-side only), Moelis dropped these numbers:

We achieved $219 million of revenues in the first quarter, up 27% over the prior year. This represented our highest quarter of revenues on record. Our performance compares favorably to the overall M&A market in which the number of global M&A completions greater than $100 million declined 14% during the same period. Our growth was primarily attributable to very strong M&A activity in the quarter. We're participating across industries and deal sizes, and we are also earning higher average fees per transaction. In addition, restructuring activity continue to be a solid contributor.

The fee part of this is interesting. Achieving pricing power in this environment is a big accomplishment. Query whether that relates more to M&A and less so to restructuring given the relative dearth of bankruptcy deal flow. Regardless, here’s what the stock did on Tuesday, a day the S&P 500 otherwise declined 1.34% and the Dow was down 424 points:

When asked about restructuring, specifically, this is what Mr. Moelis had to say:

Well, never expect things to only get better, but it's been - look, it's been a low default environment for a long time. And I think some of the peers and competitors have kind of - who were edging into restructuring might have edged out a bit; we're not. We think we have the leading restructuring group on the Street. They've been together for years and years and years, and now the way we integrate them, the amount of spread we can get using the 120 on these to really make sure that they are talking to companies that are having issues. And those issues could be opportunities, too. It's almost - it crosses over with liability management. It might stay to be a 1% or 2% default rate for a while []. You can never tell. But there's a large amount of paper out there. So even at 1% or 2%, you can stay busy if you have a market-leading restructuring group which we do. Look, it could get worse. I guess nobody could default, but I think between 1% and 0% defaults and 1% and 5% defaults, I would doubt we hit 5% before we hit 0%. So, I'm happy we held the team together, we've added to it, we've integrated it, it continues to be a solid part of our business, and I think it has a lot more upside than downside.

Ok, so this must be a misstatement. He must have meant that he doubts that we reach 0% rather than 5%. And so: A. Lot. More. Upside. In late 2019? Early 2020? Who has edged out? Will others between now and then? The analysts didn’t ask those questions.

7. What to Make of the Credit Cycle (Part 6)(Yield Baby Yield)(May 13, 2018)

This series just keeps getting better and better.

This week the Wall Street Journal reported that “junk bonds are getting junkier.” Oh boy. You have to hand it to to the private equity bros: they have a real sense of the markets these days.

At issue is the bonds financing KKR & Co’s $8.1 billion buyout of Unilever’s spreads businesses (think: Flora and I Can’t Believe It’s Not Butter). At the time of its announcement in December, it was the second largest private equity transaction in Europe. KKR reportedly beat out Apollo Global Management LLC and CVC Capital Partners for the business — a sign that with the market awash with dry power, competitive bidding is driving up asset values. In this case, the asset is suffering from declining sales in both Europe and the US. Why? Consumers are moving to healthier options.

But what choice do you, Mr. Private Equity Guy, have when you’ve just raised billions of dollars at stiff management fees and that money is just sitting in cash? What do you do when LPs are calling and asking why they should pay said management fees when they can now get 2% with a Goldman Sachs Marcus savings account or just invest in an S&P 500 index? Well, you invest in suspect assets at even-more-suspect multiples. To decrease risk, you, of course finance as much of it (on the company’s balance sheet) possible. Even better if you — knowing how desperate the market remains for yield — can take advantage of that market desperation (and unrelenting “Greater Fool Theory”) by financing the transaction subject to an unorthodox waterfall. Wait. What?

Per the WSJ,

One thing owners of junk bonds are usually sure of is that when the borrower defaults, they will get a veto on cash going to shareholders, to junior debtors or into new deals.

Not any more. Junk bonds financing private-equity firm KKR & Co.’s latest buyout subvert the usual order by allowing such payments to go ahead even after a formal default.

The $1.4 billion of bonds, to repay temporary borrowing for the buyout of Unilever PLC’s margarine business, mark a new low in the quality of covenants protecting lenders and are yet another sign of the wall of money chasing the higher yield on offer from junk bonds.

These new bonds reportedly permit restricted payments to stakeholders other than bondholders in the event of default. You read that right. KKR has reportedly upended the traditional payout waterfall so that, when the bonds go sideways, their equity is better protected. Or as Axios’ Dan Primack put it,

It's like cov-light and stupid had a baby that creditors couldn't wait to adopt.

Yield, baby. Yield.


8. What to Make of the Credit Cycle (Part 7)(Yield Baby Yield)(May 23, 2018)

First, this:

Newsflash: people are getting increasingly concerned about what the market may or may not be telling us. Let’s be clear: nobody has any clue what the market is telling us. With one exception. There is no question that the market continues to tell us this: Yield, baby. Yield. It's a borrowers' market out there.

Take Valeant Pharmaceuticals ($VRX), for instance. Just a short time ago, the company was plagued by scandal and analysts all across the markets were analyzing its severely leveraged capital structure for bankruptcy risk. Now? Per The Financial Times

"...last month the size of the outstanding leveraged loan market rose above $1tn for the first time, but such growth has brought a decline in credit quality. As Valeant boosted the size of its loan by $750m to $4.6bn, in a flexing of muscle that would have been unthinkable two years ago, it secured greater financial flexibility by loosening the covenants, or conditions, attached to its refinancing."

Riiiiight. So what, exactly, do credit investors put their money into these days? Seems like its cov-lite or bust. More from the FT:

Now, the vast majority of loans are “cov lite”, which lack covenants meant to govern a company’s financial metrics. According to data from S&P Global, the number of cov-lite loans in April rose to 82 per cent of loans tracked, up from about 20 per cent in 2011. 

“There is no point in talking about financial covenants any more, or calling a deal ‘cov-lite’,” said Christina Padgett, a loan analyst at Moody’s. “They are all cov-lite. Cov-lite is the new normal.”

Agreed. We should just reframe the narrative. From now on, any issuance that actually has covenants in it should just be called, "Covenanted loans." Anything withoout that designation — apparently now 82% of issuances — should just be called "Loans." Period. Does anything encapsulate a lapse in memory quite like this chart? 

The rise in "Loans" from 2012 to now is amazing. Again, yield baby. Yield.

There has to be more than just rate-chasing that is driving this lunacy right? Well, yes, as a matter of fact: the fervent zeal for collateralized loan obligations. Remember those? Per the FT,

Companies are issuing a larger share of senior debt in response to booming demand for collateralised loan obligations, securitisation vehicles that primarily buy senior secured debt.

Indeed, per Deutsche Bank,

At the end of 2017, new CLO issuance reached USD120bn in the US and EUR 20bn in Europe, setting post-crisis record across both markets.

But wait, there's an additional array of nonsense infecting "Loans." Add backs, for instance, are popping up, obscuring levels of corporate leverage in the process and inflating numbers for covenant compliance purposes. Awesome.  

Given this, why shouldn't issuers be more and more aggressive — with loans or bonds? SRS Distribution apparently acted as if it were asking the same question; it recently went to market with $380 million of unsecured bonds (subordinated to $1.7mm of first lien debt) — to fund its buyout by private equity firm Leonard Green & Partners — with, as reported by the Financial Times, "some of the worst covenants" ever seen by Covenant Review. 

To which our first reaction was: at least it has…some…covenants…?

9. What to Make of the Credit Cycle (Part 8)(June 4, 2018)

TCW Group recently released its Loan Review through April ‘18 and it is telling. Per the commentary:

CLOs represent nearly 50% of the buyer base for loans and April was a huge month for CLOs to be priced, reset and refinanced. There were 28 new issues and 32 resets and repricings, which set a monthly record for the market. Many CLOs require being reset on the coupon date, which led to April being an extraordinarily high month of issuance.

As of April, the CLO markets have printed $43 billion year-to-date, a 58% increase YOY. And per LCDNews, the markets have printed an additional $10+ billion in MayPer Bloomberg,

The frenzied buying isn’t limited to older securities -- Wells Fargo & Co. is forecasting that there will be a record $150 billion of new U.S. CLOs issued this year. Moody’s Investors Service, the biggest bond grader for CLOs, can’t keep up with the demand for its services, and is taking around a month more to rate the securities than it needed before.

The demand for loans is apparently overwhelming supply. Of note (by TCW):

The dynamic of demand overwhelming supply has not only allowed borrowers to continue to refinance their spreads at a lower rate, it has created an environment where sponsors and borrowers alike continue their assault on credit agreements. April witnessed the persistent practice of extremely aggressive EBITDA addbacks, which help to create adjusted EBITDA that makes leverage seem more reasonable at closing.

That’s what helps drive this chart: weaker credits increasingly accounting for leveraged loan issuance:

Query how bad you must suck if you cannot get a loan launched in this environment (cough, cough, looking at you American Axle & Manufacturing). Indeed, per Bloomberg:

That strong demand is allowing managers to sell CLOs with weaker protections, and it’s making the leveraged loans that get bundled into the securities riskier too. Investors are buying CLOs because they are floating rate: they offer protection against rising interest rates and against losses if loans default. The securities performed relatively well during last decade’s financial crisis. But risks are building for CLOs now, investors said.


But at some point, the economy and credit markets will shift, and whenever that happens, losses from loans will likely be higher than they’ve been historically, according to Hu. Covenants are generally weaker, and more borrowers have loans as their only form of debt, which can force creditors can take more losses. When the credit cycle does turn, investors used to recovering around 77 cents on the dollar from first-lien loans to failed companies may find themselves with closer to 60 cents, Moody’s Investors Service forecast in March.

“We need to have a risk management approach in how we think about the CLO market now,” Gene Tannuzzo, a money manager at Columbia Threadneedle Investments, said. “It feels a lot like 2006; you’re hearing of new, smaller entrants and we should be prepared to see riskier issuers. This market is no longer a secret.”

Not surprisingly, the loans that have performed the worst are retail, consumer non-durables and consumer durables, with returns of 2.24%, 2.03% and -2.58%, respectively. In other words, the #retailapocalypse, “Amazon Effect,” and other hackneyed excuses are filtering their way all the way through the loan markets, including securitizations. No surprise there, really, but worth noting:

Still, as of April 30, the S&P/LSTA Index imputed default rate was 1.10%, the second lowest level since October 2007.

In summary,

Loan performance was strong in April driven by many of the same technical characteristics that have driven loan performance in 2017 and 2018. CLO generation remains robust both in terms of actual new issue and in terms of resetting deals. Rising LIBOR continues to drive investors into loan funds via mutual funds and separately managed accounts. Mergers and acquisitions and leveraged buyout volumes remain insufficient to satiate demand. In the absence of true net supply, borrowers and sponsors continue to aggressively reprice existing loan deals.

In other words, don’t expect the “yield, baby, yield” trend to end anytime soon. It continues — with really extenuating exceptions — to be an issuer’s market.

10. What to Make of the Credit Cycle (Part 9)(Long Yield, Baby. Yield)(June 24, 2018)

A. M&A is En Fuego

PwC released an analysis of M&A activity. In summary:

The number of deals north of $5 billion is on pace to double last year’s total, and to date has driven overall deal value up by more than 50%, according to a PwC analysis of Thomson Reuters data. Deals are also getting bigger, with more announced deals of at least $30 billion so far in 2018 than in all of 2017.

Since the start of 2018, one-third of megadeals crossed sector lines, driven largely by an appetite for new technologies. That interest in tech hasn’t been limited to huge transactions, with examples of smaller deals coming in retail, media and printing.

Companies are looking to broaden their customer base. And they have a ton of cash on balance sheet to do it:

B. Loan Issuance is Also En Fuego

Of course, all of that cash isn’t deterring companies from tapping the capital markets.

Per LeveragedLoan.com:

In one of the largest credits of its kind, a Bank of America Merrill Lynch–led arranger group has launched a $3.75 billion covenant-lite term loan package for Asurion that will be used to fund a return of capital to shareholders, according to sources.

Dividend deals such as Asurion are seen as opportunistic issuance in the U.S. leveraged loan market, meaning issuers – or their private equity owners – take advantage of investor demand to originate credits, the proceeds of which are returned to the owners. The U.S. leveraged loan market has been red hot of late as investors crowd the floating-rate asset class thanks to ongoing and expected interest rate hikes.

Now THAT is a solid dividend recap.

C. Bond Issuance is Also En Fuego

Per Financial Times:

Bayer had to offer US competition regulators large concessions to secure approval for its $63bn takeover of Monsanto. Bond investors have been less demanding.

A sale of $15bn of debt by Bayer on Monday to fund the acquisition was inundated with orders, allowing the German pharmaceutical and chemicals group to offer investors a lower yield than initially planned.

The heavy demand came despite the Monsanto acquisition lifting Bayer’s leverage to a level that investors say is usually reserved for riskier, high-yield bond issuers. It also illustrates the ability of companies at the bottom of the investment-grade rating scale — a group made up of BBB+, BBB, and BBB — to continue to fund large acquisitions in the debt markets, a trend summed up by AT&T’s $80bn takeover of Time Warner.

The piece is worth a read; it gives a solid overview of the market for (medium tier) investment grade bonds. Naturally, all of this activity has some concerned:

“We’ve seen this over and over again: a company does a massive deal, and the rating agencies give them the benefit of the doubt,” said Mr Forsyth of BNP Paribas Asset Management. But “not all these companies are going to meet their leverage targets”, particularly in an economic downturn.

Indeed, some fixed-income investors are worried about the long-term implications of the persistent appetite from BBB borrowers who have grown used to funding ambitious deals in the debt markets.

“The bigger concern right now is the unannounced M&A we aren’t aware of,” one trader said. “Clearly M&A has been heating up over the course of this year and, at this point, the risk is that the market continues to finance these larger transactions, particularly from BBB” bond issuers.”


D. Convertible Bond Issuance is Also En Fuego

Meanwhile, tech companies are issuing convertible bonds at a record rate.

$13.4 billion of converts have been issued so far this year — more than the height of the dot-com bubble. Twitter Inc. ($TWTR), Etsy Inc. ($ETSY) and Square Inc. ($SQ) are among the culprits looking to raise cash, forestall equity dilution and take advantage of (still) low interest rates. This is just opportunistic balance sheet management but, per Recode:

One thing worth noting: These huge spikes in the convertible bond market don’t tend to last for more than a year at a time (see chart above). And the top two years for convertible bonds in the internet era — 2000 and 2007 — were both quickly followed by market collapses. On its own, that doesn’t mean we’re due for a major correction next year. But it’s something to pay attention to.

Investors, it seems, aren’t lacking for avenues to take advantage of a rising rate environment.

11. What to Make of the Credit Cycle. Part 10. (Long Summer Associate Programs)(July 10, 2018)

Around a year ago, a biglaw partner shared with us his view that a clear-cut sign of a market top is when biglaw associate salaries go up (hat tip to ya, bud). Subsequently, per CBS, this happened:

Some lines of work pay more than others. While Americans have largely seen lackluster wage growth during the past year, the roughly 500 associates laboring at Milbank, Tweed, Hadley & McCloy just drew a large bump in pay, putting the law firm at the top of the legal heap in terms of salaries paid to attorneys just starting out.

A spokesperson for the 690-lawyer firm confirmed that it is hiking associate salaries by $10,000 to $15,000, bringing a first-year associate's salary to $190,000. A second-year associate at the firm will now make $200,000, while an eight-year associate will pull in $330,000.

The prior high mark had been set two years ago by Cravath, Swaine & Moore, which upped starting pay by $20,000 to $180,000, an industry standard that was quickly matched by Milbank and multiple other firms.

Not to be over-powered in the ever-feverish stampede for the next generation of, cough, ”legal talent,” multiple firms (got bent and) fell in line, upping associate pay to match (or exceed) Milbank’s salary raise. Count on Abovethelaw for some added color:

Summer 2018 has really been the summer of money for Biglaw associates. Milbank got the party started by finally bringing NY (and its other offices) to $190K. Simpson Thacher upped the ante just two days later by matching the new salary scale and adding in special summer bonuses. And just a few days after that, Cravath reasserted its dominance as the firm that sets the market standard by increasing the standard base salary for senior associates over what was set by Milbank. 

And yet, elsewhere in the broader macroeconomy, economists everywhere are wondering why there are underwhelming wage increases (maybe because corporate legal bills just went up?!? 🤔). Per Forbes:

Wages rose 2.7% from a year earlier in June, below the 2.8% increase economists had expected and the increase may make little difference because inflation is also picking up and could soon outpace wages, meaning many workers have no real increase in buying power.

Bloomberg adds:

There are currently 6.7 million job openings — a record high. And the rate at which workers are quitting their jobs is higher than it was before the onset of the Great Recession. But wage growth is still noticeably slower than many economists and analysts expect (despite all the stories about employers desperate for workers).

Meanwhile, after a 5% salary increase prior to even working for a single (billable) hour, entering Milbank associates be like:

(PETITION Note: hopefully those associates don’t ever run the hourly calculation).

Law students looking forward to these new riches need to work hard this summer to ensure that they get an offer at the end of their respective summer associate programs. Indeed, they need to not screw up this:*

Nothing gives a realistic snapshot of life as a biglaw attorney like axe throwing, escape the room(s), the Olympics, cooking classes, and spectacular rooftop views. We’re serious.

Really. We are.

Having the aggressiveness, discipline and vigilance of an Olympic athlete is needed to navigate the halls of a biglaw firm (PETITION Note: sadly, they don’t teach you inter-office politics in law school). Knowing how to throw an axe may actually help lawyers wade through the morass. In fact, if we were associates, we would go on a shopping spree at Best Made and hang some dope-looking axes on the wall to leverage the intimidation factor.

Escape the room? Junior associates will want to do that every Friday evening to avoid the inevitable partner phone call asking for an “urgent!!” memo on some esoteric legal question that more-likely-than-not will NEVER come up. By Monday morning, of course. (Hot PETITION tip: the likelihood of said partner reading that memo on Monday morning — let alone by the end of the following week — is roughly about 1.27%).

Cooking classes? Sh*t. The closest you’ll get to cooking once you’re making that sweet $190k is receiving someone else’s via Seamless, UberEats or Caviar. In the office. Of course.

Rooftop views? Awesome. There’s nothing more lit than having a bird’s eye view to thousands of New Yorkers living their lives eating drinking and being merry while you’re stuck in the office. Those views are a double-edged sword, broheim. Make no mistake about that.

So, again, kudos to Milbank for giving its summer associates a realistic view of the practice of biglaw.

*Milbank “promoted” this tweet, by the way, which means that it wanted the world to know that we’ve once again reached peak-summer-associate. We’re old enough to remember when firm’s swore off extravagant summer programs, reneged on summer associate offers, or deferred start dates. This will end just as well.

12. What to Make of the Credit Cycle. Part 11. (Long Size. Mattering)(July 15, 2018)

Oversized during an upturn can mean undersized during a downturn. Noted. Insert specialty bankers here.

Back in April’s Part 4 of this ongoing series, we noted and asked the following:

Interestingly, certain investors have become impatient and have apparently thrown in the towel. Is late 2019 or early 2020 too far afield to continue to pretend to deploy a distressed investing strategy? Or are LPs anxious and pulling funds from underperforming or underinvested hedge funds? Is the opportunity set too small - crap retail and specialized oil and gas - for players to be active? Are asset values too high? Are high yield bonds priced too high?

These questions were a preface to coverage of a Wall Street Journal report that indicated that a variety of distressed-debt hedge funds are abandoning — or have already abandoned — the strategy. In contrast, however, we highlighted that, elsewhere in the world of distress, there were entrepreneurial types who think now is an opportune time to be getting in on the business, not out. We wrote:

Speaking of leading indicators(?) and opportunity, clearly there are some entrepreneurial (or masochistic?) investors who are prepping for increased distressed activity. In December, The Carlyle Group ($CG), via its Carlyle Strategic Partners IV L.P. fund, announced a strategic investment in Prime Clerk LLC, a claims and noticing administrator based in New York….


On April 19th, Omni Management Group announced that existing management had teamed up with Marc Beillinson and affiliates of the Beilinson Advisory Group (Mark Murphy and Rick Kapko) to purchase Omni Management Group from Rust Consulting.

We summed up the activity by stating:

The point is: some opportunistic folk sure seem to think that there’s another cycle coming. And they’re putting their money where their mouth is, thinking that there will be money to be made in the (seemingly saturated) case administration business. Time will tell.

Subsequently, in June, Warburg Pincus, the $44 billion New York-based private equity behemoth announced an investment in Reorg Research, a leading research provider in the distressed debt space.

Meanwhile, if you haven’t heard of litigation finance you must be living in a hole somewhere (or be billing 3,000 hours a year). Every lit-fin firm under the sun appears to be beefing up its potential restructuring capabilities. There’s JefferiesFortressBurford CapitalLongford Capital, etc. etc. And now, Parabellum Capital has launched its special situations group, bringing over former Wachtell lawyer Martin Flics (as an advisor) and Jarvis Buckman from Knighthead Capital. Apparently a lot of folks think there’ll be bankruptcy activity to finance. 🤔

And, so, speaking of putting money where their mouths are, this week Guggenheim Partners has agreed to buy Millstein & Co., the advisory firm led by restructuring banker, Jim MillsteinPETITION readers will recall that, back in January, Guggenheim (led by Scott Minerdissued a rather cautious report about the high yield and bank loan markets, going as far as to predict a recession in late 2019 or early 2020. And that was BEFORE the trade drama that President Trump has unleashed over the last few weeks.

Mr. Trump’s actions have only bolstered Guggenheim’s conviction. Mr. Minerd doubled-down earlier this week:

DoubleLine Asset Management’s Jeffrey Gundlach added:

And so the timing of this deal appears to make a ton of sense. Per Bloomberg:

Millstein, who was the restructuring chief at the U.S. Treasury Department during the 2008 financial crisis, agreed that a mounting wall of debt in corporate America could spur a downturn because higher interest rates constrain investments. He said the excessive use of leverage in the technology and industrial industries make them vulnerable if the economy worsens, calling the convergence of so many negatives a “perfect storm.”

“This is a very scary scenario,” he said. “There’s going to be real financial distress.”

Per The Wall Street Journal:

The deal’s timing was driven in part by a belief shared by executives at both firms that debt markets may soon face a reckoning, creating a flurry of restructuring activity as the world’s economies slow.

Global debt jumped to a record $247 billion at the end of March, the Institute of International Finance said this week. And in the U.S., corporate bonds rated triple-B—the lowest rung above junk—now account for about half of the investment-grade debt market.

Right. So about those aforementioned BBBs. Per Alexandra Scaggs at the Financial Times:

The sector has ballooned in the past several years as companies took advantage of historically low interest rates to borrow in size, weakening their balance sheets and ratings in the process.

Not only is it bigger -- it has grown to 49 per cent of ICE BofAML's corporate index from 38 per cent at the end of 2009 -- the most indebted companies in the index have piled on plenty of leverage as well.

It is difficult to argue that people should care without taking a reactionary view that supports the pre-crisis status quo, however. If companies can borrow at low rates, why adhere to an outdated view that stigmatises debt? After all, the market-weighted coupon of the BBB-rated ICE BofAML index is 4.52 per cent, down from 6.68 per cent at the end of 2009.

But should investors really ignore the fact that investment-grade companies in that segment are making deals that leave them with debt that is 4 times larger than their their ebitda, a leverage level that used to qualify a company for a junk-bond rating? 

The question she posits, then, is what happens if the $3.1 billion of BBBs get downgraded (aka become “fallen angels”) and increase the supply of high-yield debt? The answer: it’s not entirely clear, but it could mean a move in spread by 50-60bp — exclusive of any effects emanating out of the downgrade trigger. Scaggs writes:

That means it does not account for the market's response to any factors that caused the downgrades in the first place, whether it is a rational response to economic weakness or an emotional flight from risky assets in recession.

Translation: depressed prices and lots of stressed and distressed paper. Oh, and good luck refinancing in that market. Godspeed to the high yield funds holding the paper. They’re going to need some rock solid advice.

With this as a backdrop, Guggenheim’s conviction is understandable.

13. What to Make of the Credit Cycle Part 12: The Decline of Financial Reporting (Long Due Diligence)(August 19, 2018)

The rise of covenant-lite debt is, by now, well-documented. By now you’re tired of reading about an issuers’ market that has investors getting bent in their fury for yield. Disregard for federal leverage ratio guidance? Check. Elimination of federal leverage ratio guidance? Check. Inappropriate yield for the amount of risk? Check. Covenant-lite? Check. William Cohan recently wrote an opinion piece in The New York Times sounding the alarm. This weekend, Barron’s joined the fray.

Moody’s Investors Service is also beating a drum. On Thursday, Moody’s noted:

Diminishing structural differences between high-yield bonds and leveraged loans will have negative consequences for investors in the next market downturn, Moody's Investors Service says in a new report. As demand for new loan issuance continues to outstrip supply, with the US syndicated leveraged loan market today topping $1 trillion, investors have increasingly relinquished control over debt structures and credit terms, contributing to the convergence of terms within the high-yield bond and loan markets and setting the stage for weaker recoveries when the current economic expansion ends.

"The combination of aggressive financial policies, deteriorating debt cushions, and a greater number of less creditworthy firms accessing the institutional loan market is creating credit risks that foreshadow an extended and meaningful default cycle once the current economic expansion ends," observed Christina Padgett, a Moody's senior vice president. "The result is more defaults than the last downturn as well as lower recoveries, undercutting a foundational premise for investing in loans."

Who do we have to blame for a lot of this increased risk in the system? Well, private equity of course. Moody’s continued:

In terms of size, the US syndicated leveraged loan market today rivals the high-yield bond market, buttressed by the expansion of collateralized loan obligations (CLOs) which now represent about 60% of the loan market. Because investors remain under pressure to meet fund mandates and increase yield, they continue to cede to borrowers' demands. Moody's cautions that such developments are also making it much more difficult for investors to be selective.

Borrowers with aggressive financial policies, particularly private equity-owned companies, have taken advantage of the convergence trends and accommodative credit markets since the advent of quantitative easing. Underscoring this more aggressive stance in financial policy is the deterioration in the distribution of US speculative-grade ratings. As reported by Moody's, the share of first-time debt issuers rated B3 reached a record 43% in the first half of 2018, and about 64% of US speculative-grade companies have a corporate family rating of B2 or lower. (emphasis added)


Remember, financial covenants — and the reporting required with respect to them — are like tripwires. They alert investors (and the market at large) as to the financial health of a company. Without those alerts, management teams can linger in a state of denial about their liquidity runway and wait until the 11th hour to engage their creditor constituencies. This just may very well have the effect of creating more value-minimizing free-falls into bankruptcy court. Good for restructuring professionals. Definitely bad for investors.


So, in a world where information dislocations and asymmetry seems to increasingly be the “it” thing, it was interesting to see President Trump suggest this on Friday:

(Might the President be speaking to Elon Musk? 🤔🤔)

The peanut gallery met the suggestion that corporations might benefit from more infrequent financial reporting with some immediate (and somewhat colorful) resistance:

BURN! 🔥🔥💥🔥🔥

Justin Lahart notes in The Wall Street Journal that, on one hand, there are reports that indicate that quarterly reporting contributes to a “myopic focus on the short-term results that is detrimental to companies’ long-term success” and that “when companies reported more frequently they invested less in their businesses.” But, on the other hand, he argues that more infrequent reporting may lead to more volatile stock swings and higher costs of capital.

Per The Wall Street Journal, Leon Cooperman of Omega Advisors is not too keen on the idea:

Mr. Cooperman described the proposed change as “superfluous,” saying “I don’t think it’s going to change how companies are managed.”

In an email, Mr. Cooperman said, “Corporate executives talk about the long term but they are all over the money managers that manage their pension assets looking at monthly and quarterly performance. Hypocritical!”

He also said, “Many companies in Europe report semiannually and as best as I can tell our markets are much more richly appraised than the various European markets.”

AxiosDan Primack added:

There is little doubt that too many public company operations are perverted by "short-termism," and it can have a negative impact on hiring.

But halving the number of reporting periods is certain to reduce the amount of information available to investors, without solving the core problem of CEOs trying to meet artificial data deadlines.

A much more commonly-suggested fix would be to change CEO incentives, primarily by decoupling compensation from short-term stock price goals.

And, of course, a regular reminder that CEOs don't need to obsess over quarterly numbers. It's a choice.

Indeed. There are other workarounds to the pressures of short-term reporting that don’t necessarily push more opacity into the system. One compromise might be the shunning of quarterly guidance: Paul Singer of Elliott Management Corp. and Larry Fink of Blackrock Inc. seem to be in that corner.

On the flip side, however, there are proponents of less short-termism — most notably Warren Buffett and Jamie Dimon.


Nelson Peltz of Trian Fund Management LP said:

“A company’s management team will be able to use the additional time that would otherwise be spent on preparing quarterly earnings releases, holding investor conference calls and making SEC filings, on running the business.”

This is the Jason Zweig WSJ piece Josh Brown refers to. Zweig wrote:

In a process I’ve called “a cynical tango-clinch,” analysts and companies dance expectations downward in tandem. Analysts seeking to curry favor with management deliberately lowball their earnings estimates, helping the companies to beat them and, over time, boosting the stock price. Company executives, in return, let the analysts and their institutional-investor clients cozy up close to them, where they may pick up hints about the future of the business.

When an analyst sets an earnings forecast too high, or a company earns less than analysts are expecting, the dance is ruined. And both sides know it. So the analysts’ estimates consistently converge toward what the company is likely to earn — while leaving just enough room for the reported earnings to exceed the expectation.

The result: surprise, surprise, surprise. To call such predictably engineered numbers “surprises” is almost absurd.

Ok, sure. That very well may be. Everyone knows that and if you’re investing based on what analysts say, you’re a straight-up buffoon. But, even in the current scenario, a market participant has the option to mute that noise, review the quarterly SEC filings, and make decisions on their own (as they should). How does eliminating quarterly reporting empower those folks. Who really cares about the analyst tango?

Luckly, Zweig chimed in again on Friday, weighing both sides of the argument. He ultimately closes with “[i]n other words, the longer bad news is delayed, the worse the market’s response.”

Putting a bankruptcy lens on, bankrupt companies engage in 13-week cash flow analysis and file monthly operating reports. They’re beholden to publicly-filed DIP credit facility operating budgets. Creditors have to file 2019 reports indicating their holdings (though, somehow, credit default swaps always seem to slip through the cracks). While the process is far from as transparent as folks purport it to be, there is, to be fair, a lot of financial reporting available to the court and the public. So much so, that the failure of Toys R Us to file its monthly operating report covering the holiday sale season was an obvious “tell” that something was askew.

From our vantage point, it definitely seems that with covenants disappearing, MiFID II, and public reporting now on the chopping block, investors will have to be on their game with their research and due diligence. In an age where information was supposed to be “set free,” there seems to be an increasing push against free-flowing information in the markets. And, to date, we haven’t seen a compelling argument for why this makes sense. If a bankrupt company has to comply with frequent financial reporting, why shouldn’t a public company with Mom and Pop investors? And Elon Musk’s reliance on Ambien doesn’t sway our view. Will an SEC study…?

14. What to Make of the Credit Cycle Part 13 (Long Yield, Baby, Yield)(August 26, 2018).

Investors have to generate yield somewhere. Hence, as we’ve discussed ad nauseum, the rise of alternative investment avenues such as venture capital and litigation finance. Wait. Litigation finance? Yes. Think Peter Thiel, Hulk Hogan and Gawker. This is a booming space. Per The Financial Times:

The growing popularity of litigation finance has been fuelled by billions of dollars from hedge funds, private equity and other institutional investors. Now a crowdfunding platform due to launch in the UK early next month is hoping to spread the word — and the high returns — to private investors.

In recent years, money has been pouring into litigation finance businesses, which provide upfront funding for claimants who cannot afford to fight legal disputes in return for a share of any settlement or damages. Most funders seek big cases where the claims for damages are in the tens of millions of dollars.


Jonathan Cary, a commercial disputes partner at the law firm RPC, said: “What was once a relatively niche product . . . is now a fully viable form of investment for a broader range of sophisticated professional investors — and if the figures are to be believed, extremely lucrative. Particularly in this era of low yield, you can see the attraction for investors.”

And a concentrated one. Much like most other asset classes, there is growing fear that too much money in the space will hike up competition and compress recoveries. Burford Capital ($BUR)IMF Bentham ($IMF)Longford Capital ManagementJefferies Financial Group Inc. ($JEF)Fortress Investment Group LLC. These are just some of the players in the space. And so sourcing will be key. After all, in the US at least, there is no shortage of litigation supply to fund.


The lender frenzy continues. Per the Wall Street Journal:

Lenders are stepping up offers of personal loans, many to consumers with poor credit histories, promising to fund home renovations, vacations and debt repayments for a group of borrowers they all but ignored in the years after the financial crisis.

American Express Co. , Goldman Sachs Group Inc., LendingClub Corp. LC and Social Finance Inc. are among those behind an onslaught of unsolicited mailings offering unsecured loans as large as $100,000. In the first half of this year, lenders mailed a record 1.26 billion solicitations for these loans, according to market-research firm Competiscan. The second quarter marked the first period that lenders mailed out more offers for personal loans than credit cards, a much bigger market, according to research firm Mintel Comperemedia.

The surge in unsecured personal loans is the latest sign that banks and financial-technology companies alike are plunging with new vigor into a risky area of consumer finance, reflecting both the solid growth of the U.S. economy and the perception that growth opportunities remain scarce for lenders nearer the top of the U.S. personal-income distribution.

Draw your own conclusions.


On the flip side, it appears that leveraged loan investors are finally growing some cajones. Per Bloomberg, investors demanded better terms on a number of deals this past week, including a syndicated loan financing the buyout of chemicals company SI Group by SK Capital Partners. 16% of loans issued in the quarter have exhibited signs of widened pricing (“flexing”) to lure investors. The choice quote:

“Valuations got a little too high and they’ve adjusted marginally, and that’s a good sign,” said PGIM’s Collins. “People are getting a little more skittish on credit risk.”

It’s about time.


Moody’s Analytics went fishing this week for signs that the current business cycle will come to an ignominious end. Noting that the US is currently in a boom phase, i.e., a period marked by “robust economic growth, tightening labor and product markets, intensifying wage and price pressures, monetary tightening, and higher interest rates,” it also highlighted that another typical feature is “excessive risk-taking somewhere in the financial system.” So, how is that feature manifesting?

Moody’s highlights that, for the most part, it isn’t. Noting overvalued asset markets and easier underwriting, Moody’s underscores that there are no tell tale signs like there were with the subprime lending, dot-com and savings and loan crises of prior periods. Of course, Michael Berry notwithstanding, there weren’t many people who saw those signs before they reared their ugly heads. Not to point out the obvious.

Overborrowed households? Moody’s says “nothing to see here.” Credit card debt. "No worries,” says Moody’s. Student loans? Meh. That’s the federal government’s issue, not the financial system’s. Budget deficits. Even Republicans who were hyper-focused on this a mere few years ago could care less. Municipals? Whatevs. So, what, then?

Well, recent market pushback notwithstanding, Moody’s pinpoints leveraged lending and CLOs and, of course, covenants (on loans and bonds) — the “it” market worries of late (and for good reason). Moody’s notes:

To meet the strong demand for leveraged loans from the CLO market, lenders are easing their underwriting standards. According to the Federal Reserve’s survey of senior loan officers at commercial banks, a net 15% of respondents say they lowered their standards on commercial and industrial loans to large and medium-size companies this quarter compared with the previous quarter. The only other time loan officers eased as aggressively on a consistent basis was at the height of the euphoria leading up the financial crisis in the mid-2000s. Standards for loans to small companies have not eased nearly as much, since they are much less likely to be bundled into a CLO.

Moody’s concludes:

Considering the leveraged loan and junk corporate bond market together, highly indebted nonfinancial companies owe about $2.7 trillion. Their debts have been accumulating quickly as creditors have significantly eased underwriting standards. As interest rates rise, so too will financial pressure on these borrowers. Despite all this, global investors appear sanguine, as credit spreads in the CLO and junk corporate bond market are narrow by any historical standard.

Regulators are undoubtedly nervous—they issued guidance to banks to rein in their leveraged lending in 2013—but an increasing amount of the most aggressive lending is being done by private equity, mezzanine debt, and other institutions outside the banking system and regulators’ purview.

Now consider that subprime mortgage debt outstanding was close to $3 trillion at its peak prior to the financial crisis. Insatiable demand by global investors for residential mortgage securities drove the demand for subprime mortgages, inducing lenders to steadily lower their underwriting standards. Subprime loans were adjustable rate, which became a problem in a rising rate environment as borrowers didn’t have the wherewithal to make their growing mortgage payments. Regulators were slow to respond, in part because they didn’t have jurisdiction over the more egregious players.

It is much too early to conclude that nonfinancial businesses will end the current cycle in the way subprime mortgage borrowers did the previous one. Even so, while there are significant differences between leveraged lending and subprime mortgage lending, the similarities are eerie.

Time to start writing “The Big Short 2.” The CDS world will be active.

15. Initiate the Deluge of Lehman Retrospectives (Short History). Part II. What to Make of the Credit Cycle. Part…? Part…Ah Eff It, We’ve Lost Count.* (September 16, 2018).

Are you tired of all of the Lehman #failureporn yet? If not, you’re in luck. We’ve curated some favorites for you.

Here, Axios does a “deep dive” on the financial crisis (including some effects thereof, including the rise in for-profit ed and tech). Here are some lessons learned from the financial crisis (The Financial Times). Here, Bloomberg discusses how distressed funds feasted on Lehman’s carcass. Choice bit:

Expected to recover just 21 cents on the dollar when the reorganization came together in 2011, they’ve so far received 45 cents. In Lehman’s U.K. unit, senior claims have gotten 140 cents on the dollar.

Here, Bloomberg Businessweek discusses how hard things have been on hedge funders like David Einhorn, Alan Howard and John Paulson who fared well during the downturn but haven’t done so well since. (PETITION Note: gIve us a frikken break). Hedge funds, generally, continue to shrink.

Brian Chappatta writes that $250 trillion of debt is Lehman’s legacy. And, given, that, Nouriel Roubini, Dr. Doom himself, writes that “by 2020, there are several reasons why conditions for a global recession and financial crisis may emerge.” JPMorgan agrees. Per Bloomberg:

A decade after the collapse of Lehman Brothers sparked a plunge in markets and a raft of emergency measures, strategists at the bank have created a model aimed at gauging the timing and severity of the next financial crisis. And they reckon investors should pencil it in for 2020.

The good news is, the next one will probably generate a somewhat less painful hit than past episodes, according to their analysis. The bad news? Diminished financial market liquidity since the 2008 implosion is a “wildcard” that’s tough to game out.

Finally, Daniel Arbess, CEO of Xerion Investments, writes this sobering take on the state of the markets. It is well worth a read in its entirety. Among other things, he notes:

In the past decade, total global debt (sovereign, corporate and household) has spiked nearly 75%. This includes a doubling of sovereign debt, from $29 trillion to $60 trillion, according to a recent McKinsey report. Total corporate debt increased by 78% over the same decade, to $66 trillion. Bank loan volumes have been stable, although low-quality “covenant lite” loans have dominated. Bond markets have filled in, with nonfinancial bonds outstanding up 172%, from $4.3 trillion to $11.7 trillion. McKinsey says 40% of U.S. companies are rated one notch above “junk” or lower, and the Bank for International Settlements estimates 10% of legacy companies in the developed world are “zombies,” meaning earnings before interest and taxes don’t cover interest expenses.

This is what zero interest rates and quantitative easing have wrought—more debt and lower credit quality. Yield-starved investors were happy to look the other way and refinance dubious credits so long as rates were low and they had no better alternative. Small wonder central banks are glacially unwinding their balance sheets and raising rates. But higher rates are coming, possibly heralding a tsunami of credit defaults.

And, finally, he concludes:

If the 10-year Treasury, the reference rate for corporate bonds, surpasses 3.25%, much less approaches its long-term average yield of 4.5%, “lend and pretend” refinancing could stop cold.

When credit turns, stocks have never been far behind. The longest-ever bull market may be closer to ending than we think—and that could be the least of our problems.


We don’t want to end this segment on that dour note. So consider this:

That’s pretty amazing.

*It’s Part 14.

16. What to Make of the Credit Cycle. Part 15. (Long Blackstone; Short Refinitiv)(September 23, 2018).

🎶 Sing it with us now: “Yield, baby, yield.” 🎼

Let’s pretend for a second that you’re a trader “sitting on the desk” of a fund with a high yield mandate. Limited partners have given your Portfolio Manager millions upon millions (if not billions) of dollars to get access to — and active management of — high yield debt. They expect your PM and the team to deploy that capital. That’s what you said you’d do when you were out pounding the pavement fundraising. They don’t want to pay you whatever your management fee is for you to simply be sitting in cash, waiting on the sidelines counting your “dry powder.” So when a big issuance goes out to market, you’ve got to make your move. The pressure is on.

The first order of business it to simply make sure that you even get in the room. You’d better be on your game. There’s a lot of appetite for yield these days, so you better be working those phones, dialing up that “left lead” clown you suffered beers with a few weeks back with the hope of getting an opportunity to put in an allocation. You’re dialing and dialing and hoping that he doesn’t remember that your PM passed on — much to your chagrin — the last 4 or 5 looks that clown — let’s call him Krusty — gave you. Fingers crossed.

Your PM is pacing behind you. It’s creeping you out. Angst fills the room. The desk lawyer is running around screaming bloody hell about some covenants or something. Maybe it was a lack thereof. You’re not sure. You don’t care, damn it. Those LPs want that money deployed so you’re damn well gonna deploy it. Forget about covenants. Forget about risk. That lawyer can pound sand. Literally nobody cares. Because you and your team are super savvy. Surely you’ll be able to dump these turds of loans and bonds before the market speaks and the debt trades down. Or before all liquidity dries up. Either way, you’ll get out. You’re sure of it. Market timing is your jam.

You finally get through. Krusty says “what’s your number?” You turn to your PM and without much time to really crunch numbers — after all, the yield, the potential discount, the Euro piece vs. the US piece all keep changing — he shrugs and throws out a hefty number. And then does the Sam Cassell dance. You smile. There’s momentarily silence on the other end. Finally, Krusty says he’ll call you back; he seems wildly unimpressed. Your PM shrinks.

You know this same scene is playing out on trading desks all over Wall Street time and time again when there’s a juicy new issuance.

And so does Blackstone. So does Refinitiv.

This week the high yield universe worked itself into a tizzy as Refinitiv priced and issued $13.5 billion of debt to finance Blackstone’s multi-billion dollar ~55% takeover of Thomson Reuters’ Financial & Risk division. Why is this a big deal? Well, in part, because its a big deal. And the lack of (high yield) supply has led to pent up demand. Pent up demand can lead to some interesting compromises.

On September 8, the International Financing Review wrote:

The debt package is divided into US$8bn of loans and US$5.5bn of high-yield bonds. Those debts, combined with separate payment-in-kind notes (with a 14.5% coupon), will result in annual interest payments of US$880m at current price talk. A separate US$750m revolving credit facility will also need servicing.

“The banks had no choice but to price it attractively and it’ll be interesting to see how it goes,” a loan investor in London said. (emphasis added).


The deal is being marketed with leverage of 4.25 times secured and 5.25 times unsecured, based on adjusted Ebitda of US$2.5bn, which includes US$650m of cost savings from the business’s reported Ebitda of US$1.9bn.

Wait. Take a step back. Cost savings? What cost savings? Blackstone is claiming that they can take $650mm out of the business thereby driving the leverage ratio down. That’s quite a gamble for investors to take. Particularly combined with loose interpretations of EBITDA and considerable add-backs.

The International Financing Review quoted some investors:

A portfolio manager in London said that he had calculated that leverage for the deal is “nearer six and seven times”.

“It’s very late cycle. I don’t really like it when you see a deal with this order of magnitude of projected cost savings as you really don’t know if and when they will be realised,” he said.

“It will be a bit of a test for the market given the size of the deal. But Blackstone and its partners have a good reputation and deep pockets.”

Moody’s and Fitch put leverage between 6.1x and 7.6x.

Covenant Review was nonplussed about the bond protections. It wrote:

“The notes are being marketed with extremely defective sponsor-style covenants riddled with flaws and loopholes that reflect the worst excesses of covenant erosion over the last two years.”

Tell us how you really feel.

Reuters channeled the ghosts of TXU:

The return of big buyouts to the leveraged finance market has rekindled memories of the 2006 and 2007 bad old days of risky underwriting and excessive debt.

So, in the end, how DID the issuance go?

The Wall Street Journal wrote:

One of the largest-ever sales of speculative-grade debt was completed with ease on Tuesday, a sign of the favorable environment for U.S. borrowers at a time of robust economic growth and strong demand from investors.

The $13.5 billion sale—which a Blackstone Group LP-led investor group is using to acquire a 55% stake in a Thomson Reuters Corp. data business called Refinitiv—comprised $9.25 billion of loans and $4.25 billion of secured and unsecured bonds, with different pieces denominated in U.S. dollars and euros.

Including a $750 million revolving credit line, the bond-and-loan deal amounted to the ninth-largest leveraged financing on record in the U.S. and Europe, and was the fourth-largest since the financial crisis, according to LCD, a unit of S&P Global Market Intelligence.

Said another way, demand was so high for the issuance that — aside from upsizing the loan component by $1.25 billion (with a corresponding bond decrease) and a reduction of future permitted debt incurrence — the company was able to offer bond investors LOWER interest rates at par, despite the fact that both Moody’s and S&P Global Ratings rated the issuance near the bottom of the ratings spectrum. Read: thanks to fervent demand, the banks were able to price a wee bit less aggressively than originally planned. That includes the loans: the company was also able to decrease the original guided discount (“OID”) for investors.

Per Bloomberg, orders

“…total[ed] double the $13.5 billion of bonds and loans it needed to raise. The scale of the response was spurred on by a ravenous bid from collateralized loan obligations and other investors amid fears that there may be fewer new deals going into the fourth quarter."

🎶 One more time: “Yield, baby, yield.” 🎼

So here you had a 2x over-subscription despite some troubling characteristics:

High leverage wasn’t the only way Refinitiv has tested investors. Under the proposed terms of its bonds, the company could pay dividends to its owners even if it came under severe financial distress, a provision that the research firm Covenant Review described as “wildly off market.”

Back to International Financing Review quoting a high yield investor:

“It got to the point where the only thing I liked about the (Refinitiv) deal was the yield. And I’ve learned after 25 years in this business, that’s not enough.”

Among his concerns were business challenges that the Refinitiv business has already faced from competitors like Bloomberg and FactSet. But Blackstone’s ambitious cost-savings target also made him leery.

“When you look at the investment thesis of the sponsor, it’s very much about achieving cost synergies,” said the investor.

“The synergies they forecast are based on their story that they know how to do this better as sponsors than the corporate parent.”

Reasonable minds can debate the merits and reality of sponsor-driven cost “synergies.” But let’s be honest. Nobody is investing in this capital structure because they are whole-hearted endorsers of the Blackstone-promulgated cost-reduction narrative.

“Among the rationales for investors is confidence in the economy - it’s looking good right now, it’s looking good next year, and the belief that they can sell before the quality of the debt deteriorates,” Christina Padgett, a senior vice-president at Moody’s, told IFR.

In other words, market timing is their jam.

17. What to Make of the Credit Cycle. Part 16. (Long Div Recaps)(September 26, 2018).

On Sunday in “What to Make of the Credit Cycle. Part 15. (Long Blackstone; Short Refinitiv),” we provided our colorful take on the fervent (and 2x over-subscribed) demand for the $13.5 billion Thomson ReutersRefinitiv loan and bond issuance. Our take was framed from the perspective of the high yield trader and was meant to provide some insight into the machinations that occur behind the scenes at a high yield fund. But what does this deal mean for private equity firms and leveraged buyouts?

Spoiler alert: all good things.

Reuters wrote:

The rousing results are likely to boost secondary pricing and will intensify pressure on primary pricing and other terms and conditions, after investors won a reprieve in the summer from aggressive transactions amid a surge in supply.

The SMi100, an index that tracks the 100 most widely held loans, stands at 98.73, the highest point since February. About 42% of US loans are now trading above par, according to LPC data. Average US high-yield bonds, meanwhile, have rallied sharply over the past couple of weeks to Treasuries plus 325bp, or just 3bp off post-crisis lows, according to ICE BAML data. (emphasis added)

Private equity firms likely smell blood in the water. More from Reuters:

The successes could also herald a more aggressive underwriting era as private equity firms squeeze arranging banks harder, which could open the door to another round of opportunistic repricings, refinancings and dividend recapitalizations that allow sponsors to take advantage of weak documentation.

“The next stuff behind the scenes is going to be punchy,” the global debt head said.

Ah, dividend recapitalizations. We miss those.

Reuters continued:

While the results are undeniably good for private equity firms, they may not be good for investors who are increasingly nervous about aggressive deals as an economic downturn draws closer at the end of an unusually long economic cycle.

With Refinitiv, Akzo and Envision, technical factors – primarily huge demand and a small visible pipeline of deals – overwhelmed any specific credit concerns and fears about aggressive documentation that allow sponsors to extract dividends quickly or make transformative asset sales and acquisitions without investors’ consent.

The three jumbo loans, each of which are capital-stretching, represent half of the forward calendar, which is already looking thinner. Worries about future supply encouraged investors to join the big, liquid deals in droves, particularly as new money carve-outs have previously proved to be particularly profitable.

All of this continues to worry financial regulators who are watching the fervor play out. The Bank of International Settlements recently warned that, per Bloomberg:

…likely distress among indebted borrowers may spread into the wider economy as central banks raise interest rates. It’s not just the total debt, but the fact that investors seem less and less concerned about protecting themselves against losses, the BIS said.

Yes, indeed. The return of covenant-lite debt has been well documented.

And the borrower-favorable market has been well documented.

“When there’s tons of liquidity, lenders don’t value covenants and they’re willing to lend at very high leverage values,” said Douglas Diamond, a finance professor at the University of Chicago Booth School of Business. “If you get a negative shock after that, you’ve now got a very vulnerable sector. The crisis won’t happen tomorrow but the vulnerability is there.”

The BIS report identified other concerns, including the prospect of fire sales by loan funds if ratings downgrades push some of their investments into junk. Diamond said there’s potential for such leveraged mutual funds to cause havoc.

“The borrowing that they do is usually from a bank,” he said in an interview. “They buy a loan from a bank, they borrow money from the bank to buy the loan from the bank -- not necessarily the same bank. So the risk would ultimately get back to bank balance sheets.”

But high yield mutual funds aren’t the only vehicles driving this meshugas. Don’t forget about CLOs, which, as we discussed in “💥The CLO Market is Going Bananas💥,” are in full-on volume mode. Relating to factors driving demand for borrower-friendly paper, Alexandra Scaggs wrote in Barron’s:

Another is the robust demand for floating-rate debt such as leveraged loans to protect against Federal Reserve rate increases. Funds investing in loans have seen $14.4 billion of inflows this year, according to EPFR, following on $16 billion of inflows in 2017 and $11 billion in 2016. It is not clear the scramble for floating-rate securities will stop any time soon, as the Fed is expected to raise rates four times in the next 12 months, according to Bloomberg data. The demand for loans has also been fueled by the rise of the market for collateralized loan obligations, securitized products that hold pools of loans as collateral and pay their investors the interest collected from those loans in order of tranche quality.

For the uninitiated, here is an excellent recently published primer from S&P Global Ratings on how CLOs function. Pour yourself a cup of coffee and give it a perusal. It’s worth it. CLO dynamics will definitely play into the next cycle.


In a separate segment on Sunday, we snarked about over-the-transom strategic-alternatives pitch deck” and banker boredom. Distressed and high yield investors are, no doubt, equally if not more bored. Aside from Q1, 2018 has been a barren wasteland for restructuring and bankruptcy professionals looking for things to do. Long bitching come bonus time.

But all of this flippant high yield activity has to come home to roost at some point. The question, as always, remains “when?”

18. What to Make of the Credit Cycle. Part 16.1. (October 7, 2018).

We discussed restructuring industry investment and consolidation in “What to Make of the Credit Cycle (Part 4),” arguing that it is a sign of bullishness for an uptick in the restructuring market. So, for those keeping score:

  • The Carlyle Group ($CG) via its Carlyle Strategic Partners IV L.P. fund, announced a strategic investment in Prime Clerk LLC;

  • Omni Management Group announced that existing management had teamed up with Marc Beillinson and affiliates of the Beilinson Advisory Group (Mark Murphy and Rick Kapko) to purchase Omni Management Group from Rust Consulting;

  • Reorg Research took on an investment from Warburg Pincus;

  • Epiq Bankruptcy Solutions LLC bought and then put Garden City Group’s bankruptcy group out to pasture;

  • Stone Point Capital invested in Gordon Brothers;

  • Guggenheim Securities snapped up Millstein & Co.; and

  • B. Riley acquired GlassRatner.

And most recently:

Based on recent precedent, that seems like a fairly safe prediction.

19. What to Make of the Credit Cycle. Part 17. (“Too Much Money Chasing Too Few Deals.”)


In his most recent letter, Howard Marks from Oaktree Capital Management L.P. unleashes a trove of stats that would be a welcome addition to our “What to Make of the Credit Cycle” series. Just read it (particularly pages 5-9).

20. What to Make of the Credit Cycle. Part 18. (Long Family Offices).

The number of billionaires in the world increased 10% from 2016 to 2017. The number of billionaires in the world increased another 30% from 2017 to 2018. Thanks Bitcoin! 😜

With this massive amassing of capital comes a desire to protect and expand that capital and, in turn, the rise of investment vehicles deployed to do so. Insert family offices here. Real Assets Advisor noted back in March:

Family offices are on the rise, and the numbers are staggering. In 2008, an estimated 1,000 single-family offices were in the world. Less than a decade later, EY reports the number has grown to more than 10,000 family offices globally. Family Office Exchange reports, while most estimates peg the current number of family office in the United States to somewhere between 3,000 and 5,000, the real figure could be closer to 6,000.

Because family offices do not have to be licensed or registered, precise figures on family offices and foundations remain somewhat elusive. Despite their growing influence and importance, family offices have been a somewhat underreported segment of the investor community.

And, yet, as we’ve previously discussed, hedge funds are on the decline. So how do these family offices tend to deploy their capital? Per the RealDeal:

Instead of going through hedge funds, private equity and other traditional investment platforms, rich people are increasingly looking to “go direct” by investing their money straight into a business, Bloomberg News reported.

“Some wealthy people don’t like being in investment pools where they don’t have a say,” explained Cascadia Capital managing director Felix Herlihy. “The thinking is by going direct their performance over time will be superior. In a way, it’s saying, ‘I’m a little bit smarter.’”

Reuters adds:

For 2018, the family offices expected their direct venture capital and private equity investments to deliver the best returns, of 13 percent, followed by private equity funds, at 11 percent, and direct real estate investments, at 8.4 percent.

“Family offices have delivered their strongest returns since we began measuring their performance five years ago,” Sara Ferrari, head of UBS’ Global Family Office Group, said.

“This reflects the bull market, as well as family offices’ ability to take a long-term approach and embrace illiquidity.”


Allocations to hedge funds, however, continued to be trimmed and represent just 5.6 percent of the average portfolio after several years of weak average performance and high fees relative to those run by traditional asset managers.

This certainly helps explain, at least thematically, the recent wave of shuttered hedge funds of late.

But it all also raises some questions. The restructuring community has spent the post-Great Recession period dealing with the replacement of conventional lenders with shadow bankers, e.g., large private-equity backed direct lenders, who are now increasingly at the top of a company’s capital structure with meaningful investments at stake. To what degree will the rise of direct private equity investment by family offices impact restructuring dynamics (in the small to middle market space, in particular) in the future? Is the industry ready for these new players? And, on the flip side, what in-house resources do these family offices have in place to deal with a downturn? Eventually we’re going to find out.


What’s some more indicia of where we are in the market cycle? Caesars Entertainment ($CZR) reentered the news with a potential transaction

Earlier this week news broke that Tilman Fertitta, CNBC impresario, Houston Rockers owner and and Golden Nugget Casino owner made overtures to Caesars about a (reverse) merger. 

Axios’ Dan Primack summed up the potential transaction best:

Why it's the BFD: Because this could be the second time that Caeasars changes hands near a market top. The first time was via a 2008 leveraged buyout by Apollo and TPG that resulted in a massive bankruptcy and restructuring.

Sometimes history does repeat itself.

Want to tell us we're morons? Or praise us? Cool, either way: email us at petition@petition11.com


NCBJ Annual, 10/28-10/31, San Antonio TX

Orrick Annual Fall Soiree, 10/30, New York NY

Cleary Gottlieb’s Fall Cocktail Reception, 10/30, New York NY

Goldman Sachs Restructuring and Distressed Investing Conference, 11/1, New York NY


Bob Riiska has joined SierraConstellation Partners (Los Angeles).

Clark D. Griffith (Managing Director) has joined White Oak ABL LLC (San Francisco) from Encina Business Credit.

Jennifer Kimble (Counsel) has joined Lowenstein Sandler LLP (New York) from Prime Clerk LLC.

John Gramins (Managing Director) has joined BTIG LLC (New York) from Capital One.

Marc Carmel (Partner) has joined McDonald Hopkins LLC (Chicago) from Longford Capital Management.

Paul Arena (Director) has joined BTIG LLC (Los Angeles) from Imperial Capital.

Tom Buck (Principal) has joined GlassRatner (New York) from EisnerAmper.

🙌Congratulations to:🙌

Akin Gump Strauss Hauer & Feld LLP on the expansion of its restructuring and global debt financing team with the hires of Renee Dailey, Chip Fisher, Christopher Lawrence and Thomas O’Connor.


We have compiled a list of a$$-kicking resources on the topics of restructuring, tech, finance, investing, and disruption. 💥You can find it here💥. Another book we’re excited to add to the list and check out is Barbara Kahn’s “The Shopping Revolution: How Successful Retailers Win Customers in an Era of Endless Disruption.”

💰New Opportunities💰

Carl Marks Advisors, a nationally recognized investment bank providing operational and financial advisory services, seeks professionals with 4+ years of transferable restructuring and turnaround and experience.  These individuals will work in an integrated team environment on a diverse range of engagements in restructuring, turnaround, bankruptcy, valuation analysis and financial performance assessments. Key attributes include strong accounting & financial modeling skills, independent judgment, resourcefulness, and creativity. NYC based position with substantial travel. Interested candidates should click here https://carlmarksadvisors.com/jobs/ to submit their CV and cover note.

Evercore (EVR) is a leading global independent investment banking advisory firm. Evercore advises a diverse set of investment banking clients on a wide range of transactions and issues and provides institutional investors with high quality equity research, sales and trading execution that is free of the conflicts created by proprietary activities. Evercore seeks to hire the following for its NY office:

  • Associate with relevant experience. For requirements and other specifications, please click here.

  • Analyst with relevant experience. For requirements and other specifications, please click here.

If your firm has job opportunities, please email us at petition@petition11.com.

Nothing in this email is intended to serve as financial or legal advice. Do your own research, you lazy rascals.