Squawk Trader – Mike Kuta (10-01-14)

Published on 10-01-2014

Fed Scrutiny of Leveraged Loans Grows Along With Bubble Concern.

The Federal Reserve is stepping up its oversight of high-risk leveraged loans, shifting to a deal-by-deal review after its previous industry-wide guidelines were largely ignored by banks. The Fed is now looking at loans each month, according to people who asked not to be identified because the information is private. Supervisors are looking at individual deals and risks such as a borrower’s ability to repay, they said. “Banks have been scolded and they have been warned, and yet you are seeing a lot of signals that the market is heating up,” said Mayra Rodriguez Valladares, managing principal at MRV Associates in New York, a consultant on regulation to some of the world’s largest banks. “We have seen this bad movie before. The issue now is, will the regulators deploy the rest of the arsenal of tools they have?” Until now, supervisors collected loan data in an annual survey, and last year told banks they needed better adherence to standards they put forth in guidelines in March 2013. Over the past several weeks, they have shifted tactics and are examining loans as they are made, showing a new urgency in avoiding the kind of overly risky lending that was blamed for igniting the financial crisis. If the latest round of heightened scrutiny doesn’t work, regulators have other options. They can change supervisory ratings on banks, which could limit mergers. They could ask boards to sign agreements to make changes, or they could resort to fines.

Yellen Test:

The $800 billion leveraged-loan market is serving as a test of whether Fed Chair Janet Yellen is able to use supervisory tools to curtail excessive risk-taking as almost six years of near-zero interest rates, intended to boost the economy, drive investors to higher-yielding assets. Yellen said in a July speech that supervisory tools should play a “primary role” in attacking asset-price bubbles. Doing so by raising borrowing costs “faces significant limitations” because it affects all borrowers, not just parts of the market where the Fed detects froth. The Fed may find that supervisory tools are too weak to curb incentives shaped by very low interest rates, said Phillip Swagel, who served as an assistant Treasury secretary during the financial crisis. “It doesn’t work so well to say, ‘Please don’t make money, please pass up deals,’” said Swagel, now a professor at the University of Maryland’s School of Public Policy. “Ultimately, it seems the Fed is going to have to change the economics of funding that is driving these markets.”  Barbara Hagenbaugh, a spokeswoman for the Fed in Washington, declined to comment.

Flagging Risks:

In March of last year, the Fed and other regulators released guidance saying debt levels of more than six times earnings before interest, taxes, depreciation and amortization, or Ebitda, raises concerns. Regulators also flagged the risk that banks will get stuck with a large amount of loans that they might not be able to sell in a market downturn. The guidance was followed by the publication of the Shared National Credits Review, an annual survey of lending trends that also noted risks in the leveraged-loan market. Regulators asked banks to show better compliance with the guidance. They later acknowledged that banks had largely ignored those efforts. Starting in September of last year, the Fed and the Office of the Comptroller of the Currency sent letters to banks giving them 30 days to come up with a plan for tighter policies, four people familiar with the missives said at the time. Recipients included Barclays (BARC) Plc, Citigroup Inc., Deutsche Bank AG, Goldman Sachs Group Inc., JPMorgan (JPM) Chase & Co., Morgan Stanley and UBS AG.

Deal Terms:

“Terms and structures of new deals have continued to deteriorate in 2014,” Todd Vermilyea, senior associate director at the Fed Board’s Division of Banking Supervision and Regulation, said in a May 13 speech in Charlotte, North Carolina. “Many banks have not fully implemented standards set forth in the inter-agency guidance.” Covenant-light loans — which lack requirements that protect lenders such as limits on debt levels relative to earnings — are on track to exceed 70 percent of issuance this year, according to a Barclays report dated Sept. 5. That would be a record. Total debt levels for large leveraged buyouts have risen to 6.26 times Ebitda in the third quarter from 5.89 times in the first half of this year, according to Standard & Poor’s Capital IQ Leveraged Commentary & Data. That compares with an average of 6.23 times Ebitda in 2007, the year the credit crisis began.

Potential Froth:

While identifying leveraged loans as a potential area of froth, regulators are focusing on underwriting rather than trading, which is still conducted away from exchanges, in telephone calls, faxes and e-mails. Even though many investors increasingly consider the debt in tandem with high-yield bonds as a way to boost returns, loans aren’t regulated as securities and take weeks to change hands, increasing the risk of a market seizure in the case of accelerated withdrawals. Bankers meeting with Fed officials on Sept. 19 said the central bank’s low-rate policy was partly to blame for the increase in leveraged lending. “Excess liquidity and extremely low interest rates create the environment to leverage existing cash flows and return capital to owners,” according to minutes of the meeting of the Federal Advisory Council. Rising leverage “is at least partially being driven higher by the absolute low interest cost and by the length of time that rates have been depressed.”

Morgan Stanley:

The group’s members include Morgan Stanley Chairman and Chief Executive Officer James P. Gorman and BB&T Corp. (BBT) Chairman and CEO Kelly S. King. The allure of high-yield leveraged loans in an era of low rates has been enhanced by interest payments that float above benchmark rates — an appealing feature as the Fed prepares to boost borrowing costs as soon as next year. Investors poured a record $62.9 billion last year into U.S. mutual funds and exchange-traded funds that buy the debt, which is typically rated below investment grade, according to Lipper, a Thomson Reuters company supplying mutual fund data. Banks have arranged about $430 billion of U.S. leveraged loans sold to investors so far this year, compared with a record $696 billion in all of 2013, according to data compiled by Bloomberg. “We are closely monitoring developments in the leveraged-loan market,” Yellen told the Senate Banking Committee July 15. “Valuations appear stretched and issuance has been brisk.”

Recent Deals:

Recent deals show why supervisors are concerned that their guidelines are being ignored. Financing for Acosta Sales & Marketing’s buyout by Carlyle Group LP (CG) increased the Jacksonville, Florida-based company’s leverage to “well above” eight times Ebitda, according to a Sept. 10 Moody’s Investors Service report. The deal includes a $2.07 billion term loan that was arranged by JPMorgan, according to Bloomberg data. Jessica Francisco, a spokeswoman for JPMorgan, and Randall Whitestone, a spokesman for Carlyle, declined to comment. TravelClick Inc., a New York-based provider of technology services to the hotel industry, obtained $560 million of covenant-light term loans in May to back its $930 million buyout by private-equity firm Thoma Bravo LLC, according to Bloomberg data. Moody’s estimated in April that the deal would increase the company’s leverage to as high as 9.7 times Ebitda, or about seven times after adjustments for deferred revenue. Credit Suisse Group AG (CSGN) led a group of banks arranging the debt, according to Bloomberg data. Drew Benson, a spokesman for Credit Suisse in New York, declined to comment. Jeff Segvich, a spokesman for Thoma Bravo at public relations firm LANE, declined to comment. “It seems like deals with higher leverage are still getting done — and with market pressure to do so,” said Alan Avery, a partner in Latham & Watkins LLP’s corporate department in New York.

U.S. factory activity grew in September, jobs increases best since early 2012.

America’s manufacturing industry expanded in September, though a tad slower than during August, while employment in the sector grew at its best pace since March 2012, an industry report showed today. Financial data firm Markit said its final U.S. Manufacturing Purchasing Managers Index turned down to 57.5 last month from 57.9 during August. The preliminary read for the index was 57.9. A reading above 50 signals expansion in economic activity. “The September PMI reading in fact rounds off the strongest quarter recorded by the survey since the financial crisis, narrowly beating the previous peak seen when the economy was rebounding from recession in the second quarter of 2010,” Markit chief economist Chris Williamson said. The output subindex also turned down to 59.6 in September from 60.7 during August, while the employment component rose to 56.4 from August’s final read of 54.6. “The labor market upswing clearly bodes well for overall non-farm payroll growth to rise above 200,000 in September,” Williamson said. “Recent months have also seen a welcome revival in export growth, suggesting trade should also help boost the U.S. economy in the third quarter,” he said. “GDP looks set to grow by at least 3.0 percent in the third quarter, with good momentum being sustained as we move into the final quarter of the year.” A read on new orders turned down modestly last month from August, Markit said.

September U.S. auto sales to rise 10 percent.

Strong demand drove U.S. new car and truck sales 10 percent higher in September, adding momentum to the industry’s best August in more than a decade, consultants LMC Automotive and J.D. Power said today. Sales rose to 1.248 million new vehicles, or a seasonally adjusted annualized rate of 16.5 million vehicles. This follows a 17.5 million annualized rate in August. “The strength in automotive sales is undeniable, as August sales performance was well above expectations and there is no evidence of a payback in September, suggesting that the auto recovery still has some legs,” LMC forecaster Jeff Schuster said. LMC raised its full-year forecast for 2014 to 16.4 million vehicles from 16.3 million vehicles. It also forecast 2015 U.S. sales at 16.7 million vehicles, “with more upside potential than downside risk,” Schuster said. At the start of this year, LMC had expected 2015 sales to be 16.5 million vehicles. Industry research firm Edmunds.com said on Thursday it expects U.S. September auto sales to show a rise of 11 percent to 1.261 million vehicles. September had one more selling day this year than in 2013. Ford Motor Co is the only automaker expected to show a sales drop, of 4 percent, Edmunds said. Ford has cut production of the top-selling vehicle in America, the F-150 pickup truck, as it readies to launch the 2015 F-150. General Motors Co, the No. 1 U.S. automaker by sales, is expected to show a 22 percent rise in September U.S. sales, as will Honda Motor Co, Edmunds said. The next biggest gains would be 17 percent by Nissan Motor Co ; 16 percent by Chrysler, a unit of Fiat SpA ; and 7 percent by Toyota Motor Corp, it added. Industry research firm Kelley Blue Book on Thursday forecast U.S. September sales will rise 9 percent to 1.24 million vehicles. KBB said GM’s rise in sales of 16 percent will trail gains by Chrysler and Nissan of 17 percent. KBB said Ford sales would fall 2.4 percent, Honda’s rise 12 percent and Toyota’s rise 7 percent.

Private Payrolls in U.S. Increased by 213,000 in September.

Companies hired 213,000 workers in September as the labor market continued to strengthen, a private report based on payrolls showed. The gains in employment last month followed a revised 202,000 increase in August, according to the ADP Research Institute in Roseland, New Jersey. The median forecast of 41 economists surveyed by Bloomberg called for a September advance of 205,000. Stronger demand for goods and services is prompting companies to hold the line on firings and expand headcount. Continued progress in the labor market will be needed to boost aggregate income and drive consumer spending, which accounts for almost 70 percent of the economy. “There’s more overall income being earned because there are more people working, and that helps propel consumer spending upward,” said Robert Stein, deputy chief economist at First Trust Portfolios LP in Wheaton, Illinois. “When jobs are growing around 200,000 a month, you have more earners out there.” Estimates in the Bloomberg survey ranged from payroll gains of 160,000 to 255,000. August’s figure was revised from a previously reported 204,000. Goods-producing industries, which include manufacturers and construction companies, increased headcount by 58,000 in September, according to today’s report. Construction employment rose by 20,000 and factory payrolls climbed 35,000, today’s report showed. Payrolls at service providers increased by 155,000.

Company Size:

Companies employing 500 or more workers added 77,000 jobs. Employment at businesses with 50 to 499 employees increased 48,000 and the smallest companies boosted payrolls by 88,000, the report showed. “Job gains remain strong and steady,” Mark Zandi, chief economist at Moody’s Analytics Inc., said in a statement. Moody’s produces the figures with ADP. “Especially encouraging most recently is the increasingly broad-based nature of those gains.” The ADP report is based on data from businesses with more than 21 million workers on their combined payrolls. Staffing firm Adecco Group North America said it’s trying to fill more than 12,000 jobs in the customer service and fulfilment fields for a U.S.-based client, with full-time, part-time and work-from-home positions available. The seasonal jobs have the potential to become permanent positions, the company said in a statement. Hiring is currently taking place in cities in Georgia, Wisconsin, Florida, Kentucky and Virginia.

‘Coming Back’

“It’s a wonderful thing to see the economy coming back,” said Lauren Griffin, a senior vice president with Adecco, said in the statement. “We’re happy to be adding jobs across the country ahead of the upcoming holiday season.” Labor Department data may show this week that payrolls added 218,000 workers in September after a 142,000 increase the month prior that was the smallest this year, according to the median estimate in a Bloomberg survey. The jobless rate probably held at 6.1 percent. Federal Reserve policy makers monitoring labor market progress as they plot monetary strategy. Fed Chair Janet Yellen and her colleagues have signaled that they would be willing to push unemployment below its so-called natural rate as they wind down their bond-buying program and weigh the timing for future interest rate increases. Central bankers tapered monthly bond buying last month to $15 billion in their seventh consecutive $10 billion cut, according to the policy statement after the Federal Open Market Committee’s meeting last month in Washington.

Hong Kong Protesters Step up Pressure on Leung to Quit.

Hong Kong’s pro-democracy protests swelled for a sixth day as student leaders renewed an ultimatum for Leung Chun-ying to resign after jeering the city’s top official at a ceremony to mark China’s National Day. Demonstrators poured back into the three main protest areas at 6 p.m. local time after crowds thinned this morning. With Hong Kong celebrating two days of holidays, numbers may grow beyond last nights tallies, when organizers estimated at least 100,000 people in the main protest areas and tens of thousands more at the secondary sites. Leung arrived by boat at Golden Bauhinia Square to mark the 65th anniversary of the founding of the People’s Republic of China, where the Chinese and Hong Kong flags were hoisted. At the ceremony, Leung defended China’s plan to vet candidates for the city’s first leadership election in 2017. His backing of the proposal has fueled the protests and stoked calls for him to quit. “It’s understandable that different people have different ideal proposals for political reforms,” Leung said. “But having universal suffrage is better than not having it. Five million people being able to pick the chief executive through one-man-one-vote must be better than the 1,200-member election committee” under the current system.

Threat Escalation:

The movement, kick-started after students stormed the premise of government headquarters on Sept. 26, grew after police used tear gas over the weekend to disperse crowds. Student leaders said they would escalate the protests and may surround Leung’s official residence, just above the central business district, if he didn’t resign tomorrow. In a sign that a negotiated solution may be possible, Lester Shum, deputy secretary-general of the Hong Kong Federation of Students, said the group may be willing to hold talks with Carrie Lam, the city’s second-highest ranking official. “We are optimistic,” 17-year-old student leader Joshua Wong told reporters at the site of the National Day ceremony. “We hope C.Y. can bear the responsibility and step down as soon as possible,” he said, referring to Leung by his initials. After the flag raising, Leung and other dignitaries drank champagne on a red stage in a reception hall festooned with Chinese and Hong Kong flags as a white-coated band played patriotic tunes. Hundreds of protesters faced police outside the ceremony, booing the chief executive and calling for fully-free elections. Later, asked about the protests, Zhang Xiaoming, head of China’s liaison office in Hong Kong said “The sun continues to shine,” according to Cable TV.

Global Solidarity:

The protests, the biggest challenge to China’s authority since the end of British colonial rule, are in their sixth day and have triggered demonstrations of solidarity globally. Events are being held today in 60 cities from Wellington to Kyoto, Oslo to London and Houston to Toronto, according to the Twitter and Facebook pages of event organizer, United for Democracy: Global Solidarity with Hong Kong. Democracy activists in Taiwan gathered in Taipei, at a rally attended by Wang Dan, a survivor of the Tiananmen Square crackdown in 1989, when the People’s Liberation Army was used to crush the student-led democracy demonstration. New York will hold an “umbrella rally” in Times Square, a reference to the umbrellas demonstrators used to defend against pepper spray fired by the police. Today also marks the start of Golden Week, a week-long break in mainland China when hundreds of thousands of tourists typically travel to Hong Kong, fueling retail sales. Chow Sang Sang, the city’s second-largest jewelry chain, shut six shops today, while some restaurants used bicycles to to bring in supplies with protesters blocking roads. Dolce & Gabbana and Fendi stores on Canton Road in the Tsim Sha Tsui district popular with Chinese visitors were also closed.

Golden Week:

“It’s still too early to gauge how much business we lose during the Golden Week,” Chow Sang Sang sales operations director Dennis Lau said in an interview. “It may be a headache for some shoppers trying to go to districts such as Mong Kok and Causeway Bay as buses and taxis aren’t running.” The economic loss for shopping malls and office buildings is at least HK$40 billion ($5.2 billion), China Central Television reported yesterday, citing business associations. The protests aim to paralyze transportation, harm the rule of law and disrupt business to pressure the government into accepting “various unreasonable demands,” CCTV reported. “I now urge protesters to please leave peacefully and orderly,” Steve Hui, chief superintendent of the police public relations bureau said today. “Their actions have been delaying some emergency services,” he added. Stocks slumped this week, giving the benchmark Hang Seng Index its biggest two-day drop since February. Markets will resume trading on Oct. 3. “I don’t know what the hell is going on in Hong Kong,” said Zheng Tian, 40, a tourist from Ningbo. “It’s very inconvenient for me to drag my two luggages all the way to the hotel as taxi drivers refused to come to this area. Shops are closed, food is out of stock at restaurants, what am I supposed to do here?”

Fannie Mae, Freddie Mac Plunge After Court Ruling on Profit.

Fannie Mae and Freddie Mac plunged in early trading after investors including Bruce Berkowitz’s Fairholme Capital Management LLC lost a legal bid yesterday to force the bailed-out companies to share profits with private shareholders. Fannie Mae fell 66 percent to 97.5 cents in New York. Freddie Mac dropped 64 percent. The investors sued for breach of contract over allegedly promised dividends and liquidation preferences, and what they called an illegal “taking” under the U.S. Constitution. U.S. District Judge Royce Lamberth rejected their claims, finding that the government is allowed under a 2012 amendment to the companies’ bailout agreements to sweep “nearly all” profits from Fannie Mae and Freddie Mac to the U.S. Treasury. “Judge Lamberth’s ruling represents a material setback for GSE shareholder claims both in court and on Capitol Hill,” Isaac Boltansky, an analyst at Compass Point Research & Trading LLC, said in a note to investors, using an abbreviation for government-sponsored enterprises.

Specter of Russian Capital Controls Puts Market on Edge.

Holders of Russia’s ruble-denominated bonds, stung by the worst losses in emerging markets in the third quarter, are weighing the consequences of possible capital controls as the currency sinks. “It would be very negative for your investments in the local currency,” Peter Schottmueller, who helps manage $17 billion as head of emerging-market fixed income at Deka Investment GmbH in Frankfurt, said by e-mail yesterday. Foreign ownership of ruble bonds has dropped and any curbs on capital flows would further “increase the investment risk,” he said. Russia removed its last restrictions eight years ago after imposing them in 1998, when the ruble’s drop led to a default on sovereign local-currency debt. Implementing the curbs again risks further damaging President Vladimir Putin’s ambition of turning Moscow into a financial hub at a time when escalating U.S. and European Union sanctions over the Ukraine crisis are already limiting access to global capital markets. The yield on Russia’s 10-year bonds increased to a one-week high and the ruble slid to a record low yesterday after two officials with direct knowledge of the discussions said the Bank of Russia is weighing temporary capital curbs should the flow of money out of the country intensify. The ruble recovered most losses after the central bank said it wasn’t considering imposing limits on cross-border flows of money.

Capital Flight:

Government ruble notes lost 16 percent in dollar terms last quarter, the biggest decline among sovereigns in the Bloomberg Emerging Market Local Sovereign Index, which dropped 1 percent. Outflows soared to $74.6 billion in the first half, compared with $61 billion in all of 2013, central bank data show, as sanctions have threatened to push Russia’s $2 trillion economy into a recession. As much as $120 billion may leave the country this year, Interfax cited Deputy Economy Minister Alexey Vedev as saying Sept. 22. The ruble fell beyond 44.40 against the Bank of Russia’s basket of dollars and euros yesterday, the level at which the central bank said it would intervene. It then pared declines yesterday and traded 0.4 percent higher at 44.0872 at 2:44 p.m. in Moscow today.

Worst Performance:

“Outflows should sharply increase now,” Stanislav Kopylov, who helps manage 45 billion rubles ($1.14 billion) at UralSib Asset Management in Moscow, said by phone yesterday. “When you’re threatened like that, you need to urgently pull out the cash.” The currency slid 14 percent versus the dollar in the three months ended yesterday, the worst drop among 24 emerging markets tracked by Bloomberg. The yield on 10-year bonds increased 102 basis points, the most after Turkish debt in developing nations. The ruble’s share of global trading dropped to 0.4 percent in August from 0.6 percent since 2012, falling five places to rank 18th most-traded in the world, according to the Society for Worldwide Interbank Financial Telecommunication, or SWIFT.

Sanctions Pinch:

Russia’s central bank is studying all possible scenarios on how to implement capital controls, according to the people, who asked not to be identified because no decision was made. They gave no timeline and said such measures would be preventative. The country probably won’t take the step unless its currency reserves start dropping by more than $20 billion a month, Vladimir Osakovskiy, an economist at Bank of America Corp., said in e-mailed comments yesterday. The discussions are the latest sign that sanctions are hurting Russia and making its central bank rethink policies it sought to avoid. German Chancellor Angela Merkel said the EU and the U.S. may be facing a long confrontation with Russia.

Lost Efforts:

The central bank widened the ruble’s trading band in August to prepare to adopt a free float next year, a policy shift that would make interest rates rather than tapping reserves the primary mechanism for controlling currency movements and managing inflation. The bank last intervened in May. “Capital controls will erase the job the central bank and the government have done in promoting the ruble, not only as a national currency, but as a currency used in settlements with international partners,” Alexander Losev, the chief executive officer of Sputnik Asset Management, said by e-mail yesterday. Such a move would also weaken “efforts in achieving ruble stability,” he said.

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