Debt Is Back, But This Time It’s Corporate

Companies are floundering in a river of debt of their own creation.

By David Malone and cross-posted from his blog, Golem XIV. 

On Wednesday Feb 7th 2007 HSBC issued a profit warning.  It was the first in its 142 year history. The bank told its share holders it would have to take an unprecedented charge of $10.5 billion because one of its units, its sub prime lender, was in deep trouble. And so began the sub prime crisis.

Today GE issued a profit warning and cut its dividend to share holders from 12 cents to 1 cent. It is only the third time since the Great Depression that GE has reduced its dividend in this way. It told its share holders it would be taking a $22 Billion charge because one of its units, its power unit, is in deep trouble. GE has about $116 billion in debt.

In 2007 the banks had flooded the global market with sub-prime loans. The banks were also holding many of those same loans themselves or had transferred them to Special Purpose Vehicles (SPVs) they had set up, staffed and lent money to.

Today it is not the banking world which stands at the centre of the storm but the corporate world. In the last years they have flooded the market with junk rated bonds. At the same time they are also burdened with high yielding, leveraged and covenant- lite loans. Taken together they are about $2.4 Trillion of debt.

2007 sub prime loans. 2018 corporate junk bonds and leveraged loans. 2007 banks and SPVs funded by the banks. 2018?

Where is this sub-prime corporate debt sitting today?

Nearly half sits in Insurance Companies and Pension funds.

Given the close ties between insurance and pensions this is not a happy picture.

Along side the pension and insurance industry who are sitting on a mountain of high risk/high return junk there is the liquidity trigger of bond backed, fixed income and high yield ETF’s. They are admittedly still small compared to the still larger mutual funds but they are a choke and panic point. The ETF market is broad in its consumer appeal but very narrow where it counts – in who makes and provides the heavy lifting for the market. There are about 5 main companies who ‘Sponsor’, which means run and control ETF’s globally. They are BlackRock, Vanguard, State Street, Invesco and Charles Schwab. According to Forbes in 2017. According to Forbes in 2017,

The Five Largest ETF Providers Manage Almost 90% Of The $3 Trillion U.S. ETF Industry

Of those 5,

…the top 3 ETF providers dominate the market with a combined market share of 82% …  the top-three players also account for more than 70% of all ETF assets globally.

The sponsors in turn rely for the heavy financial lifting – to buy and sell the assets that go into an ETF – on what are called the Authorised Participants. Who are they? The main ones are … the big banks like Merrill Lynch, Fortis bank, Morgan Stanley, HSBC, Barclays, Citi etc. Some companies are both sponsor and authorised participant.

And some of those banks are also the people who have extended the leveraged loans and revolving credit lines to GE and others. Something its banks may come to regret. Because as of today GE is now shut out of what is called the Commercial paper market which is essentially very short duration bonds. This means GE is now reliant for much of the cash flow it needs for day to day operations upon revolving credit from its banks.  The same banks who also buy GE bonds to put into their ETFs.

What could possibly go wrong?

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