This is the first in a series of blog posts on the ongoing collapse in high yield and distressed debt bond funds. Securities litigators should take note, as the companies and funds mentioned are likely to be the source of investor lawsuits.
High Yield and Distressed Debt, Now Offering:
The Liquidation of the Rentiers
In The General Theory, Keynes wrote about the euthanasia of the rentier (rentiers being people who lived off of the interest from their investments). He was contemplating a situation where capital was so abundant that the rate of interest would decline to a level that the rentiers could not survive off of the interest received from the bonds they owned.
Rentiers were held in low regard because they did not derive their income from labor or from capital investment. They were viewed as parasites that lived off their accumulated wealth, instead of investing in ventures that would create employment.
Today's rentiers are retired baby boomers who have saved a nest egg for retirement. A far cry from a Keynesian parasite.
However, modern day retirees have faced a euthanasia nonetheless. In a wicked irony, capital has become abundant because the Federal Reserve has lowered interest rates to effectively zero and purchased trillions of dollars of Treasuries and mortgage-backed securities. (Ironic because Keynes believed the government should serve as demand of last resort, but in this case the government turned into the euthanasiaist.) This has reduced the need for retiree's savings, and commensurately, the interest to be earned on their investments.
To understand exactly how far this has gone, one only needs to review the Federal Reserve Quarterly Report on Balance Sheet Developments. I have extracted a table from the most recent report, below.
Table 1: Federal Reserve Balance Sheet Data[1]
|
Domestic SOMA securities holdings Billions of dollars |
||
|
Security type |
Total par value as of October 28, 2015 |
Total par value as of July 29, 2015 |
|
U.S. Treasury bills |
0 |
0 |
|
U.S. Treasury notes and bonds, nominal |
2,347 |
2,347 |
|
U.S. Treasury floating rate notes |
* |
* |
|
U.S. Treasury notes and bonds, inflation-indexed1 |
115 |
115 |
|
Federal agency debt securities2 |
34 |
35 |
|
MBS3 |
1,744 |
1,735 |
|
Total SOMA securities holdings |
4,240 |
4,231 |
|
Note: Unaudited. Components may not sum to total because of rounding. Does not include investments denominated in foreign currencies or unsettled transactions. * Less than $500 million. 1 Includes inflation compensation. 2 Direct obligations of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. 3 Guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae. Current face value of the securities, which is the remaining principal balance of the securities. |
||
Seeking to avoid financial euthanasia, many retirees have been forced to seek riskier and riskier investments to generate the income they need to live. While they may have avoided euthanasia, it is less likely they will avoid liquidation.
Indeed, the liquidation phase has just begun.
The Hunt For Yield
As the Federal Reserve has euthanized retirees they have been forced to reach for yield. Two of the most popular investment destinations have been master limited partnerships (“MLPs”) in the energy sector and high yield/distressed debt funds. The MLPs were entirely energy plays and the high yield/distressed debt funds were heavily exposed to energy.
Both of them have blown up and are now in a classic Minskian debt deflation. This will only resolve itself after many waves of asset (and debt) liquidation.
Distressed Debt Funds in Distress
Many fund and other firms exposed to high yield and distressed debt have announced their own distress in the past week. Some of those include:
- Third Avenue Focused Credit Fund (“Focused Credit”) suspended distributions and announced a plan to put its assets into a "liquidation trust" and give interests in the trust to its shareholders in lieu of cash.[2]
- Stone Lion Capital Partners L.P., a distressed debt hedge fund also suspended redemptions.[3]
- Lucidus Capital Partners, announced that it had received significant redemptions in October and has wound down its high yield debt funds.[4]
- Fixed Income house Jefferies an 83 percent decline in Fixed Income Revenue. The 4th Quarter Report stated: “Almost all of our Fixed Income credit businesses were impacted by… the collapse in the global energy markets (where we have long been an active adviser, capital raiser and trader), reduced originations in leveraged finance and meaningfully reduced liquidity.”[5]
To get an idea of the capital destruction going on in energy, the charts below are instructive.
Chart 1: Chesapeake Energy 5 ¾’s of 23[6]
Chart 2: Kinder Morgan, Inc. Equity Common Stock[7]
The pain is also spreading to leveraged loans, as seen in the PowerShares Senior Loan ETF chart below.
Chart 3: PowerShares Senior Loan ETF[8]
In my next post, I will examine what has happened in the energy sector and its impact on the Third Avenue Focused Credit Fund and others.
__________
Notes:
[1] Quarterly Report on Federal Reserve Balance Sheet Developments; November 2015. Available at: http://www.federalreserve.gov/monetarypolicy/files/quarterly_balance_sheet_developments_report_201511.pdf. Accessed December 13, 2015.
[2] Third Avenue Funds Focused Credit Fund Shareholder Letter. December 9, 2015. Available at: http://thirdave.com/wp-content/uploads/2015/12/FCF-Shareholder-Letter-12-2015.pdf. Accessed December 13, 2015.
[3] The Wall Street Journal. “Stone Lion Capital Partners Suspends Redemptions in Credit Hedge Funds. Rob Copeland. Available at: http://www.wsj.com/articles/stone-lion-capital-partners-suspends-redemptions-in-its-oldest-fund-1449870782. Accessed December 13, 2015.
[4] Bloomberg; “Lucidus Has Liquidated $900 Million Credit Funds, Plans to Shut”; Christine Harper; December 14, 2015.
[5] Jefferies Group LLP Fourth Quarter Financial Results; December 15, 2015. Available at: http://investor-relations.jefferies.com/Cache/1001205242.PDF?Y=&O=PDF&D=&fid=1001205242&T=&iid=102756; Accessed December 16t, 2015.
[6] Source: Bloomberg. December 15, 2015.
[7] Source: Bloomberg. December 15, 2015.
[8] Source: Bloomberg. December 15, 2015.
For information about high yield and distressed debt expert Jack Duval, click here.
