Don’t ask how I missed this story,, “Debt fears heighten in US and Europe,” in my early a.m. survey of the Financial Times; it’s the lead page one item in the print edition. As far as I can tell, the underlying news story, the dumping of leveraged loans at distressed prices, has not been picked either in the US financial media or the major blogs.
Note one of the triggers was flight from mutual funds, a sign of deep-seated investor worry. And because Wall Street holds large unsold inventories of LBO loans, these sales will force them to value their holdings even lower, leading to further writedowns and hits to their already-impaired capital bases.
On a mundane level, we are witnessing a classing pattern: the credit markets expect another leg down of economic activity, while the stock market is not (yet) of that view. Most Wall Street analysts are forecasting some deterioration in corporate profits during the year, but a return to business as usual by the fourth quarter.
From the Financial Times:
Fears about corporate and commercial property debt reached new heights in the US and Europe on Friday as investors liquidated holdings in a sign of spreading credit turmoil.
The markets were gripped by worries that economic weakness would affect corporate profits, leveraged buy-outs and commercial property. This represents an escalation of the crisis that began with concerns about US subprime mortgages.
The trading was particularly heavy in leveraged loans – used by private equity firms to finance deals.
Mutual funds that invest in these loans have been hit with redemptions, forcing them to dump some of their holdings.
Hedge funds that bet on the likelihood of buy-out deals happening have been among the casualties. The turmoil has also put pressure on banks and other investors who are holding $200bn (£103bn) of leveraged loans that they had been hoping to sell.
Kevin Cronin, portfolio manager at Putnam Investments, said: “The overhang of bank debt from last year’s leveraged buy-out activity is becoming more problematic.
“Loans are being liquidated at distressed prices and banks are looking to reduce risk.”
Loans used to finance two of last year’s biggest buy-outs, utility TXU and credit card processor First Data, were among those hit, Mr Cronin said.
Closely followed measures of credit risk in the US and Europe peaked as investors unwound complex trades that lose money when credit deteriorates.
Europe’s Markit iTraxx index, which measures the cost of buying credit insurance against defaults by investment grade companies, hit a record 97.75 basis points. The US Markit CDX index of 125 investment grade companies hit a record 133bp, up from 78bp at the start of the year.
The triple-A index of the CMBX series, which measures the performance of commercial mortgage bond deals, reached a record 235bp.
Ted Wieseman, an economist at Morgan Stanley, said: “Investor worries about potential further writedowns are shifting in a big way from subprime residential mortgages to commercial real estate lending,”
Investors sought the safety of government bonds, sending the yield on the two-year Treasury down 11bp to 1.94 per cent. The S&P 500 fell 0.4 per cent.