Subprime Meltdown in Debt Markets
Yesterday we mentioned the lack of Feb defaults in the high yield bond market. February was the first time in more than nine years that no speculative grade companies defaulted, Moody's said last week.
This indicates a certain complacency and lowered tolerance for risk in the general markets. On that note, CDOs May Bring a Subprime like Bust for LBOs and Junk Debt.
Demand for investments to use in CDOs has helped push risk premiums lower for everything from home loans to high-yield, high-risk bonds, forcing managers to borrow ever more money to maintain returns and stand out from the competition.
Sales of CDOs, which package loans, bonds and derivatives into new securities, rose by almost 50% to $918 B last year.
Managers of CDOs backed by speculative grade loans are borrowing as much as 13 times the amount they raise in equity from investors.
41% of the 142 CDOs backed by corporate loans and rated by Moody's Investors Service last year were set up by 1st time issuers.
Many of these managers are young and green having never managed in an environment of heightened risk or downturn. When defaults increase, an inexperienced manager may have more trouble selling or limiting losses.
The CDOs are financing a record number of high risk sub prime loans to low rated borrowers that forgo standard investor protections, such as quarterly limits on the amount of debt relative to earnings.
Some $36 B of these loans were made this year, more than the previous 10 years combined. As a result, about $173 B of CDOs backed mainly by U.S. subprime mortgage bonds and related derivatives were created last year.
Insurance premiums are on the rise... Yield premiums for BBB rated bonds issued by CDOs that hold some of the riskiest mortgage debt have soared to 6 percentage points over benchmark rates from 3.65 percentage points.
Yield spreads on AAA pieces more exposed to losses than super-senior bonds have about doubled in the last three months to 1 percentage point.
Unlike David Lereah the chief economist for the NRA, the Nattering One believes that subprime delinquencies will spill over into the CDO market, and the possibility that ALL of the BBB's will blow up is not unreasonable.
How bad could this get?? CDOs with loans and AAA ratings yield 23 basis points over benchmark rates, that's 10 basis points more than top rated regular corporate bonds.
Pension funds, insurance companies, universities, state and municipal governments needing to match assets to liabilities have been gobbling up the CDO's.
Through CDO's, LBO's or leveraged buy out loans financed 57% of the record $1.55 trillion of mergers and acquisitions last year, the most in seven years.
About $154 billion of CDOs that focus mainly on loans were created in 2006, up from $68.2 billion in 2005.
Does anyone remember the largest municipal failure in US history? In Dec 1994, Orange County filed bankruptcy due to a derivatives unwind.
And remember, the OC was holding a portfolio of leveraged reverse repurchase agreements and inverse floaters based on only the highest AAA rated debt.
The $1.7 billion in derivatives losses incurred by Orange County coincided with the value of local residential real estate dropping by between $1.6 and $3.2 billion.
This indicates a certain complacency and lowered tolerance for risk in the general markets. On that note, CDOs May Bring a Subprime like Bust for LBOs and Junk Debt.
Demand for investments to use in CDOs has helped push risk premiums lower for everything from home loans to high-yield, high-risk bonds, forcing managers to borrow ever more money to maintain returns and stand out from the competition.
Sales of CDOs, which package loans, bonds and derivatives into new securities, rose by almost 50% to $918 B last year.
Managers of CDOs backed by speculative grade loans are borrowing as much as 13 times the amount they raise in equity from investors.
41% of the 142 CDOs backed by corporate loans and rated by Moody's Investors Service last year were set up by 1st time issuers.
Many of these managers are young and green having never managed in an environment of heightened risk or downturn. When defaults increase, an inexperienced manager may have more trouble selling or limiting losses.
The CDOs are financing a record number of high risk sub prime loans to low rated borrowers that forgo standard investor protections, such as quarterly limits on the amount of debt relative to earnings.
Some $36 B of these loans were made this year, more than the previous 10 years combined. As a result, about $173 B of CDOs backed mainly by U.S. subprime mortgage bonds and related derivatives were created last year.
Insurance premiums are on the rise... Yield premiums for BBB rated bonds issued by CDOs that hold some of the riskiest mortgage debt have soared to 6 percentage points over benchmark rates from 3.65 percentage points.
Yield spreads on AAA pieces more exposed to losses than super-senior bonds have about doubled in the last three months to 1 percentage point.
Unlike David Lereah the chief economist for the NRA, the Nattering One believes that subprime delinquencies will spill over into the CDO market, and the possibility that ALL of the BBB's will blow up is not unreasonable.
How bad could this get?? CDOs with loans and AAA ratings yield 23 basis points over benchmark rates, that's 10 basis points more than top rated regular corporate bonds.
Pension funds, insurance companies, universities, state and municipal governments needing to match assets to liabilities have been gobbling up the CDO's.
Through CDO's, LBO's or leveraged buy out loans financed 57% of the record $1.55 trillion of mergers and acquisitions last year, the most in seven years.
About $154 billion of CDOs that focus mainly on loans were created in 2006, up from $68.2 billion in 2005.
Does anyone remember the largest municipal failure in US history? In Dec 1994, Orange County filed bankruptcy due to a derivatives unwind.
And remember, the OC was holding a portfolio of leveraged reverse repurchase agreements and inverse floaters based on only the highest AAA rated debt.
The $1.7 billion in derivatives losses incurred by Orange County coincided with the value of local residential real estate dropping by between $1.6 and $3.2 billion.
Comments
Number comes from Standard & Poors, broadcast by Bloomberg in this piece....
http://www.bloomberg.com/apps/news?pid=20601109&sid=ae1pbMY8FCGM&refer=home