In 2014, I’ve focused extensively on America’s latest credit bubble due to the fact I believe we have now entered the final “crack-up boom” phase where things just get downright ridiculous. In early May, I wrote an article highlighting the triumphant return of some of the worst practices of the pre-financial crash era in the post: Is the Credit Bubble Popping? Carlyle Group Warns on Frothiness and Junk Bond Deals Get Pulled. In it, I noted two particular types of resurgent debt deals:
The first of these are known as “dividend deals.” For those of you who are unfamiliar with them, you might not believe what they actually are. Basically, dividend deals are when companies owned by private equity firms tap the credit markets, and then a sizable percentage of the money borrowed is used to cut a check to the private equity owners themselves. Often times, the remainder of the debt is used to refinance existing debt.
Yes, you heard that right. The money earned from credit issuance isn’t used to expand operations, it isn’t spent on R&D, or anything productive whatsoever. Rather, funds are used to pay money directly to the private equity owners. From a private equity owner perspective, this is free money and of course they will take it. The insane thing is that creditors are willing to buy this garbage, and buying it they are. By the billions. In fact, you might own some in your mutual fund or pension fund. Who fucking knows, but this is insane.
The second sign of insanity is the increase in “payment-in-kind” notes. What this means is that interest on the debt can be paid back in, wait this is no joke, more debt! Even crazier, we are seeing examples of “payment-in-kind” notes being issued for the purpose of paying out dividends to private equity owners. I want to know which fund managers are buying these notes, and you should too.
Meanwhile, in a separate post titled, Leverage in PE Deals Soars Despite Fed Warnings, I noted that The Federal Reserve and the Office of the Comptroller of the Currency last year issued guidance urging banks to avoid financing leveraged buyouts that would rest in a debt/EBITDA ratio of over 6x. Of course no one gives a shit what the Fed says, what matters is what the Fed does, and the Fed has quite intentionally promoted what is now a nuclear debt bomb on planet earth.
Frighteningly, all these insane practices have finally come together in an orgy of financial irresponsibility also known as the planned $150 million bond issuance by Wave Division. It is both a “dividend deal” and “payment in kind” (PIK) bond, and to top it all off, will result in debt/EBITDA of 6.9x.
Bloomberg: reports that:
WaveDivision Holdings LLC, the West Coast cable provider taken private two years ago, is borrowing $150 million to pay a dividend to owners including Oak Hill Capital Partners LP and GI Partners LLC.
The five-year securities will have a payment-in-kind option, allowing the company to pay interest with additional debt, according to Standard & Poor’s. The credit-rating company ranks the bonds B-, six levels below investment grade. Moody’s Investors Service rates the securities one level lower at Caa1.
Companies are taking advantage of the Federal Reserve’s easy-money policies by selling PIKs, one of the riskiest forms of debt. Issuers have sold $2.94 billion in eight PIK deals to pay dividends this year, compared with $1.74 billion in five offerings in the similar period of 2013, according to data compiled by Bloomberg.
WaveDivision’s offering reflects an “aggressive” financial policy and will increase its ratio of debt to earnings before interest, taxes, depreciation and amortization to 6.9 times from 5.9, according to a Moody’s rating statement.
Meanwhile, as if you needed any more evidence of the financial lunacy happening, Bloomberg published a separate piece yesterday titled, Subprime Trading Like It’s ’07 in Car-Loan Bonds. The article notes that despite rising delinquencies in subprime auto loans, investor demand remains insatiable, and yields spreads are near record lows. We learn that:
In response to rising default rates on subprime U.S. auto loans, bond investors are deciding the best thing to do is pile into securities backed by the debt.
In the market where auto loans to people with spotty credit are bundled into bonds, the difference in yield between the lowest-rated securities and the safest has narrowed to the least since August 2007, according to Wells Fargo & Co. data. Demand for the bonds is translating into cheap funding for lenders, allowing them to make even more loans though payments more than 60 days late are on the increase.
“People have to reach further and further,” said David Schawel, a money manager at Square 1 Bank in Durham, North Carolina. “The objective now is to reach a certain yield target instead of feeling good about the underlying credit.”
Aided by low interest rates, the U.S. auto industry has been one of the bright spots of the economic recovery. Vehicle sales rose 11 percent to 1.61 million in May, bringing the annualized pace to 16.8 million, the most since February 2007, according to researcher Autodata Corp.
The subprime auto segment has ballooned since contracting following the financial crisis. Private-equity firms, attracted by the high margins, have flocked to the business during the past three years. New York-based Blackstone Group LP acquired Irving, Texas-based subprime lender Exeter Finance Corp. in 2011, the same year that Perella Weinberg partnered with CarFinance Capital LLC.
The influx of new players to the business has fueled concern that companies are lowering underwriting standards to win business.
Not surprising to see the private equity giants at the center of this fiasco as well.
Defaults on the debt are climbing as the segment reaches an “inflection point” with borrowers falling behind and loan terms easing, S&P analyst Amy Martin said in an interview in March.
At this point, I’d like to extend a big thank you to the morons at the Federal Reserve. The fascist cartel that continues to intentionally feed billions into the pockets of the 0.01% at the expense of humanity.
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