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Wednesday, July 25, 2007 8:21 PM

Avalanche of Leveraged Loan Supply

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The Liquidity crunch took another step forward today as California Home-Loan Defaults Rise to a Decade High.

California mortgage defaults rose to the highest level in a decade in the second quarter as falling home sales and higher interest rates battered the housing market.

Homeowners received 53,943 default notices, more than double the 20,909 filed a year ago, DataQuick Information Systems, a La Jolla, California-based provider of real estate data, said today in a statement. Last quarter's default level was the highest since the fourth quarter of 1996, when 54,045 notices were recorded in California.

Californians are struggling to repay home loans as mortgage rates jumped to an 11-month high and tighter lending standards limited their ability to refinance. Southern California home sales last month slumped 36 percent to the lowest for a June in 14 years and San Francisco Bay Area sales fell 26 percent to a 12-year low, mirroring the national slump, DataQuick said last week.

Most of the loans that went into default in the second quarter were originated between July 2005 and August 2006.
Once again it is important to remember this is nearer to the beginning of the beginning rather than the beginning of the end. Housing can and will get much worse.

With that sentence, a telepathic question just snuck in: "OK Mish, that is housing, what about the leveraged buyout market?" The answers come from Bill Gross at Pimco who reports "Enough is enough" and from a Citi presentation that states there is an avalanche of leverage loan supply.


Bill Gross is saying Enough is Enough.
Both borrowers and lenders may have bitten off more than they can chew, and even those that swallow their hot dogs whole – Nathan’s Famous Coney Island style – are having a serious bout of indigestion. Several hundred billion dollars of bank loans and high yield debt wait in the wings to take out the private equity and leveraged buyout deals that have helped propel stocks to Dow 14,000. And lenders…mmmmm, how do we say this…don’t seem to have much of an appetite anymore. Six weeks ago the high yield debt market was humming the Campbell’s soup theme and now, it’s begging for a truckload of Rolaids.

As Tim Bond of Barclays Capital put it so well a few weeks ago, "it is the excess leverage of the lenders not the borrowers which is the source of systemic problems." Low policy rates in many countries and narrow credit spreads have encouraged levered structures bought in the hundreds of millions by lenders, in an effort to maximize returns with what they thought were relatively riskless loans. Those were the ABS CDOs, CLOs, and levered CDO structures that the rating services assigned investment grade ratings to, which then were sold with enticing LIBOR + 100, 200, 300 or more types of yields. The bloom came off the rose and the worm started to turn, however, when institutional investors – many of them foreign – began to see the ratings downgrades in ABS subprime space. Could the same thing happen to levered structures with pure corporate credit backing? To be blunt, they seem to be thinking that if Moody’s and Standard & Poor’s have done such a lousy job of rating subprime structures, how can the market have confidence that they’re not repeating the same structural, formulaic, mistake with CLOs and CDOs? That growing lack of confidence – more so than the defaults of two Bear Stearns hedge funds and the threat of more to come – has frozen future lending and backed up the market for high yield new issues such that it resembles a constipated owl: absolutely nothing is moving.
Avalanche of Leveraged Loan Supply

Take a look at a few of these charts courtesy of Citi.

Avalanche of Supply

The Leverage Cycle

Typical CDO Haircuts

Blackstone IPO

The highly touted Blackstone IPO was arguably a watershed event just as the merger of AOL and Time Warner was back in the dotcom bubble. I was wondering if the market would start choking on or after the IPO. Well we have our answers. The IPO was a success but the patient is now looks sick.

Blackstone - BX

Bloomberg is reporting Blackstone Stock's Slide Makes It Second-Worst IPO.

Shares of Blackstone Group LP, which paid founder Stephen Schwarzman $684 million in its June IPO, have posted the second-worst performance for a U.S. initial public offering this year.

Shares of the New York-based private equity firm fell 15 percent in their first month of trading, according to Bloomberg calculations. Clearwire Corp., the wireless Internet service provider that went public in March, fell 20 percent in the first month. Last week, U.K. hedge fund manager Man Group Plc raised less than planned in the U.S. IPO of its MF Global brokerage unit. Its shares have fallen 10 percent.

Rising defaults in the subprime mortgage market have forced banks to tighten lending criteria and that in turn has affected borrowing costs for leveraged buyouts as well. Debt investors have backed away from buying risky issues, causing at least 35 companies to rework or abandon their LBO financing.

Rival buyout firm Kohlberg Kravis Roberts & Co., which also plans an IPO, was unable to sell $10 billion of senior loans to fund its buyout of pharmacy chain Alliance Boots Plc, two people with knowledge of the deal said today.

Chrysler, a unit of Stuttgart, Germany-based DaimlerChrysler AG, abandoned plans to sell $12 billion of high-yield, high-risk debt to finance its purchase by Cerberus Capital Management LP, investors briefed on the decision said today. Banks led by JPMorgan Chase & Co. will assume $10 billion of that debt and Cerberus and DaimlerChrysler agreed to hold the remaining $2 billion.

Tougher conditions in the credit market have spilled over to IPOs of other financial-services companies.
Widening credit spreads are not good for financials in general, and inability to funds CDOs and leveraged buyouts sure won't be good for the profits of broker dealers. Let's take a look at a few broker/dealer charts.

Goldman Sachs - GS Daily

The failure to hold the 200EMA maked the daily chart look quite sick. The weekly chart, however, does look better.

Goldman Sachs - GS Weekly

The implications are ominous if the 50EMA does not hold on a weekly basis.

Merrill Lynch - MER Daily

On a daily basis this chart is really busted with not only a close well under the 200 EMA but with the 50 EMA crossing under the 200 EMA as well.

Merrill Lynch - MER Weekly

Bear Stearns - BSC Weekly

Lehman - LEH Weekly

Lehman is yet another busted chart. Only GS has a weekly trendline intact. None have a daily trendline intact. Broker Dealers breaking down is not a sign of strength.

Everyone was waiting for a catalyst for a credit bust. If this is indeed it (and history has yet to speak), some may point to Blackstone, others to subprime contagion, others to Bear Stearns, but I don't think there really was one.

Earlier today I made the case that a Liquidity Crunch Looms. Kevin Depew also picked up on that theme in "Five Things" with a post about the Credit Crunch.

Whether or not this is "IT", the appetite for funding IPOs at insanely low spreads is simply not unlimited just as the appetite for housing was not unlimited (regardless of what anyone thought about demographics). If risk preferences are shifting (and it seems like they are) equities in general are simply not the place to be. Worse yet is an avalanche of supply right as the cycle has turned, when leverage has never in history been greater.

Mike Shedlock / Mish

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