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| Shark bites
A gift for the people. Yesterday, the Department of Labor issued guidelines stating that private equity is an appropriate investment for retirement plans such as 401Ks. Labor Secretary Eugene Scalia told reporters that the guidance “helps level the playing field for ordinary investors and is another step by the department to ensure that ordinary people investing for retirement have the opportunities they need.”
The DoL has company in that view. While current rules restrict p.e. to so-called accredited investors (those with $1 million in assets or $200,000 in annual income), the Securities and Exchange Commission last year suggested relaxing those rules in order to “expand investment opportunities while maintaining appropriate investor protections and to promote capital formation.”
The highly illiquid nature of private equity portfolios and discretionary price marks figure prominently in p.e’s appeal. In the first quarter, the buyout portfolios of industry heavyweights KKR & Co., Inc., The Blackstone Group, Inc., Apollo Global Management, Inc. and the Carlyle Group, Inc. were down an average of 15.8%. By comparison, publicly traded single-B-rated companies (usually the highest credit rating of p.e.-backed companies) in the S&P 500 absorbed losses closer to 50%.
While regulators look to open the p.e. door to Joe and Jane Six-Pack, the downside of illiquidity is on display. Institutional Investor reports today that the S.E.C. “is looking into” valuation problems in the bond market during the March asset-price swoon, as difficulty in ascertaining the true clearing value of rarely-traded debt securities led certain credit-themed hedge funds to suspend redemptions.
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Leveraged loans (i.e., floating-rate, tradable bank debt issued by speculative-grade borrowers), figure prominently in the private equity playbook, as p.e.-backed companies account for over 60% of the loan market according to estimates from S&P’s LCD unit. The asset class thrived in the post financial crisis epoch, growing at a 10.2% compound annual rate in the nine years through December, compared to 3.7% growth for junk bonds. Last week, a New York judge dismissed an investor lawsuit claiming that a loan syndicated by J.P. Morgan Chase & Co. should be officially designated as “securities,” and subject to the same disclosure rules as stocks and bonds.
In issuing his opinion, Federal District Judge Paul G. Gardephe cited the presumptively informed loan market investor: “It would have been reasonable for these sophisticated institutional buyers to believe that they were lending money, with all of the risks that may entail, and without the disclosure and other protections associated with the issuance of securities.” Currently, the S&P/LSTA Leveraged Loan Price Index trades at 90 cents on the dollar, up from the March lows of 76 cents, but well off the recent highs of 97.3 in January, prior to the pandemic and lockdown.
Collateralized loan obligations, or packaged and securitized collections of leveraged loans, present their own potential for broader complication. On Tuesday, the Bank of Japan and the Japanese Financial Services Agency regulator warned that local institutions should pay heed to risks within CLOs, which account for roughly half of the leveraged loan universe. With banks and investors in Japan forced to reach for yield, CLOs have become investment de rigueur: Japan’s five largest banks held a combined $126 billion in CLOs as of March 31, largely concentrated at the triple-A level.
Trouble is afoot down the CLO credit spectrum. Yesterday, Moody’s added 241 CLO securities to its watchlist for potential downgrade, joining 859 such tranches which have been under review since April. Together, the watch-listed securities now account for roughly 25% of all outstanding CLO notes, and, while none of those tranches is rated triple-A, eight are rated double-A and 51 are rated at single-A.
Risks in the underlying loans themselves are even more pronounced, if the actions of rating agencies are any guide. Thus, the rolling three-month ratio of downgrades to upgrades within the S&P/LSTA Leveraged Loan Index reached an eye-popping 43 to 1 at the end of May, LCD reported yesterday. Over the last 12 months, the downgrade-to-upgrade ratio stood at 8.5 times, easily topping the 5.3 times peak in 2009.
Come on in, mom and pop. The water’s fine.
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| | QE progress report
Lucky sevens: Reserve Bank credit (or the Fed’s sum total of interest-bearing assets) rose to $7.1 trillion this week, up $42 billion from a week ago. While down from a $137 billion sequential increase in last week’s reading, the latest move was enough to nudge the three-month annualized growth rate to 700% from 655% on May 27. Relative to a year ago, Reserve Bank credit is up 82%.
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| Recap June 4
Bear steepening action in Treasurys continues apace, as the 10- and 30-year yields jumped to 0.82% and 1.63%, respectively, with each at their highest since March. Stocks took a pause after a feverish recent run, as the S&P 500 finished modestly in the red, while gold climbed back to $1,716 an ounce and WTI crude held at $37 a barrel. The VIX ticked to 25.5, its third straight decline.
- Philip Grant
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