🔥F.E.A.R.🔥

⚡️What. The. Hell.⚡️

This week was a complete and utter sh*tshow. There’s no sugar-coating it. As fears about coronavirus rose, the stock market got absolutely annihilated — the S&P dipped over 11% for the week (one of the most severe declines in history) and the Dow dropped approximately 4000 points — precipitating a rabid shift to safety in the markets: the 10-year treasury hit a record low, dipping below 1.2%. Leveraged loans, meanwhile, got napalmed.

About a month ago 60% of the $1.2T in outstanding US #leveragedloan debt was priced at 100 or better. A week ago it was 38%. After today just 10% of that debt is priced at par #COVID19US #economy pic.twitter.com/1PcVaWjzbU

— Leveraged Loans (@lcdnews) February 27, 2020

Majors like Apple Inc. ($AAPL), Mastercard Inc. ($MA) and Microsoft Inc. ($MSFT) lowered guidance and Goldman Sachs Inc. ($GS) issued a report indicating lowered growth expectations for the year — to zero. Yep, zero. The VIX “fear index” jumped into the 40s after being virtually catatonic for years. Now there’s widespread speculation that the FED will lower rates to stimulate the market — a controversial strategy given (a) the sheer volume of money already flushing through the system and (b) the fear that the FED will be ill-equipped to then address any subsequent recession.

There are a lot of restructuring implications — on both sides of the fence. On one hand, lower interest rates ought to help a number of companies with floating-rate loans. It’s clear that the rising interest rate catalyst that many expected — and the FED quickly shot down last year — is nowhere near becoming reality. Secondly, oil and gas prices are getting smoked and given that those commodities constitute huge input costs, companies will see some savings there. Theoretically, lower oil and gas prices should also help stimulate the consumer which, we all know, had been carrying both the economy and stock prices to recent (clearly inflated) highs.

That is, unless they stay home and do nothing other than watch Netflix ($NFLX) and Disney+ ($DIS) and order bottled water and canned goods from Amazon ($AMZN) and Walmart ($WMT) — assuming, of course, that third-party fulfillment isn’t affected by supply chain disruption. Interestingly, both the consumer staples and discretionary spending ETFs are down over 10%. And the former more than the latter, which, when there’s a flight to safety pushing treasury rates down, doesn’t make much sense. So 🤷‍♀️. Corporations are, one by one, curtailing business travel, cancelling conferences, and encouraging stay-home work as advisories abound about congregating in mass group settings. This is impacting the airlines and movie theaters, naturally. The MTA ought to see a decline in ridership which ought to dig a bigger budget deficit hole (PETITION Note: Is NYC f*cked?).

Transports are getting smoked too. SupplyChainDive writes:

The COVID-19 outbreak and resulting quarantines have led to a record number of blank sailings, according to the latest figures from Alphaliner. Inactive fleet size has swelled to 2.04 million TEUs or 8.8% of global capacity. The decline is greater than the 1.52 million TEUs of canceled capacity during the 2009 financial crisis, the previous record, 11.7% of the total fleet at the time.

The Ports of Los Angeles and Long Beach are facing 56 canceled sailings over the first three months of the year, the ports told Supply Chain Dive.

Note that we had previously asked “Short the Ports?” in “🚛Dump Trucks🚛” here.

Here is The Washington Post highlighting a world of hurt at the ports:

…shipping container traffic both coming and going from the ports of Los Angeles and Long Beach has been sliding at an average rate of 5.7 percent a month since the beginning of last year….

Port of Los Angeles is projecting a 25% drop in container volumes this month, as the economic impact of the coronavirus spreads across shipping operations and foreign supply chain. Imagine if 1 in 4 goods imported from Asia suddenly stopped coming. Impact just starting.

— Eric Lipton (@EricLiptonNYT) March 1, 2020

Pour one out for the shippers.

Of course, none of this is positive for sectors that are already massively struggling, i.e., restaurants. Nor retail. Per CNBC:

If the coronavirus spreads in the U.S., that could mean really bad news for U.S. mall owners, according to a survey taken this week.

The survey by Coresight Research found that 58% of people say they are likely to avoid public areas such as shopping centers and entertainment venues if the virus’ outbreak worsens in the United States. The group surveyed 1,934 U.S. consumers 18 and older.

The survey was taken Tuesday and Wednesday — before California said it was monitoring 8,400 people for COVID-19.

Back to energy. Energy bonds are getting smoked as massive outflows flee the sector.

Some violent moves in energy junk bonds. One example: Whiting Petroleum bonds have lost almost half their value in a month, losing 12.5 cents on the dollar today alone. pic.twitter.com/8Neb8ltmz0

— Lisa Abramowicz (@lisaabramowicz1) February 27, 2020

Today it's like the Sorcerer's Apprentice here, with alerts flooding in every few minutes on outsized drops and new record lows for #distresseddebt bonds. The drought for the #restructuring and #bankruptcy advisers may be over.

— Rick Green (@RickGreenNYBiz) February 28, 2020

OPEC meets next week to discuss a massive production cut. From a restructuring perspective, it’s likely irrelevant at this point.

We’re heading into redetermination season for oil and gas explorers and producers and, given the rapid decline in oil and gas prices, banks are likely to take a stern stance vis-a-vis borrowing base levels. That ought to help usher in another wave of oil and gas restructuring.

Hold on to your hats, folks.

High Yield Investors May be Underestimating Tax Reform

Guggenheim Advises Caution in its High Yield & Bank Loan Outlook

2017 was a year marked by record institutional bank loan issuance ($504b, driven in part by high CLO demand) and robust high yield issuance ($276b, up 20% from '16). So, now what? 

On January 18, Guggenheim released its "High-Yield and Bank Loan Outlook." We've taken the liberty of summarizing it for you. The following highlights - edited for brevity and clarity - are Guggenheim's conclusions/observations unless indicated otherwise:

• FED Action Will End the Business Cycle. "With the unemployment rate likely headed to 3.5 percent, we think the net result will be a faster pace of Fed hikes in 2018 than policymakers or financial markets currently expect. Tighter monetary policy will, in turn, begin to put the brakes on the economy, bringing us closer to the end of the business cycle."

• A Recession is Coming in Late 2019 or Early 2020. Tightening monetary conditions in an over-levered economy will push the US into recession. See "Forecasting the Next Recession."

PETITION NOTE: If true, we very well may see job loss in the restructuring industry. Two years is an awfully long time to wait for increased volume in a world where the majority of deal flow is increasingly consolidated among fewer and fewer firms who, by extension, are the only players with pricing power. As price compression continues to afflict virtually every other professional in the stack (other than, maybe, to a lesser extent, the lawyers), something will need to give. We'd expect to see some capitulation among the financial advisory and investment banking ranks. 

PETITION NOTE 2: Notwithstanding the foregoing (and to be a little more optimistic for the industry), FOMO and the new Tax Reform legislation may just form the basis for some balance sheet action (for non-retail credits) in the near term...

• Late-cycle Credit Standards in the Loan/HY Market are Worrisome. 0% LIBOR floors + weak covenants = no bueno loans. 0% Libor floors reflect a tremendous amount of demand by investors and also suggests "that investors assign only a low probability of a recession occurring within anticipated holding periods, which is typical late-cycle behavior." Compounding matters, "[b]y the end of 2017, covenant-lite represented 80 percent of the loan market outstanding compared to roughly 30 percent just five years ago." With an average high-yield corporate bond earning only slightly north of the 10-year Treasury on a loss-adjusted basis, average high-yield investors are receiving inadequate compensation for the (liquidity and credit) risk they are taking. Notably, Moody's tracking of high-yield covenant quality "shows that we are near the worst level since they began tracking it in 2010."

PETITION NOTE 3: Demand driving the LIBOR floor down to 0% - in the face of unprecedented bank loan issuance - demonstrates how much dry powder rests within the system currently. It also demonstrates a tremendous lack of discipline in the face of FOMO and/or LPs who are undoubtedly questioning why they're paying management fees to managers when they could simply put money in high yield index funds. 

PETITION NOTE 3.1: You may want to check what's in those high yield index funds.

• Tax Reform Will Plunder the High Yield Market. "It is hard to identify just one area of weakness that will ultimately be responsible for toppling the U.S. economy into recession, but we have our eye on some fragile segments of the economy. The passage of the Tax Cuts and Jobs Act has been largely viewed as positive for corporate bottom lines, consumer spending, and business investment, but there has been less time spent analyzing the adverse effect of certain provisions within the Act. Among them is the change to net interest deductibility: Under the new bill, companies can no longer deduct all of their net interest expense from earnings before taxes are calculated. Net interest deductions are now capped at 30 percent of EBITDA, and in a few years this will become stricter with the cap calculated on earnings before interest and taxes (EBIT). Our review suggests this will affect 40 percent of borrowers in the high yield corporate bond market, and could create a tax liability for companies that previously may not have had one."

• More on Tax Reform. Tax Reform may serve as a BIGLY shock to leveraged companies. "For companies with significant debt burdens, such as those in the oil and gas industry, materials, and media, the impact of a lower corporate tax rate will likely be negated by the inability to deduct interest expense above 30 percent of EBITDA." Of 363 individual issuers of non-real estate high-yield credit with greater than $50mm of EBITDA as of last quarter, 137 individual issuers could be impacted by the new limit. The most impacted sector is energy (33 companies), followed by media, leisure and materials. The most impacted industries are utilities (8 companies, 80% of the universe), financial services (5 and 71%), and media (20 and 56%). Guggenheim predicts this may not end well for the average high-yield investor. 

PETITION NOTE 4: For all of those folks who gave us feedback that PETITION focuses too much on Amazon/retail, you very well see a lot more diversity if Guggenheim is correct about all of this.