Levered debt bets unravel, exposing Wall Street risk - Bloomberg
Since the 2008 financial crisis, regulators have been preventing banks from taking on extreme leverage that almost toppled the industry.
But it seems there's always someone willing to take those risks in the hopes of getting a larger payoff. Recently, several different kinds of trades based on leverage fell apart, Bloomberg reports.
Citigroup (NYSE: C) tried to sell off $1.3B of risky loans to unwind leveraged bets by clients. Funds that borrow to invest in mortgage bonds led to a wave of liquidations, and large municipal-bond funds are also selling billions of dollars in positions.
The collapse in prices for risky debt is pressuring investors to put up more collateral or unwind leveraged trades. That leads to a vicious cycle, where rapid liquidations push prices down, potentially triggering more margin calls and sales.
Citi and Truist Financial (NYSE:
TFC) had to sell off hundreds of millions of dollars in leveraged loans after the price on the debt sank to 10-year lows. The loans were behind total-return swaps, a kind of derivative where investors get amplified exposure to a debts performance.
Short-dated credit default swaps, which insure investment banks against initial losses on investment-grade and high-yield bonds, are another trade at risk. In some cases, the implied leverage of such trades are as much as 100x.
The decline for leverage loans is also hitting collateralized loan obligations, vehicles that sell an equity slice and interest-paying bonds so they can invest in loans. To get them started, the CLO managers typically draw on a form of financing called warehouse facilities.
Goldman Sachs (NYSE:
GS) and JPMorgan Chase (NYSE:
JPM) recently demanded that some CLO manager put up more cash against those warehouse lines after loan prices dropped.
Mortgage real estate investment trusts also rely on borrowing money to build up their holdings, which helps drive higher returns than just collecting interest coupons from the underlying debt.
New Residential (NYSE: NRZ) has been selling off portfolio debt with a face value of $6B at a discount in recent days. And another mREIT, AG Mortgage Investment Trust, said it had failed to meet margin calls from financing counterparties.
Nuveen, BlackRock (NYSE:
BLK), Pacific Investment Management Co., and Invesco (NYSE:
IVZ) liquidated $2.5B of tender-option bond trusts. Such trusts issue floating-rate notes to money-market funds and use the cash to buy higher-yielding long-term bonds.
“You have junkier and junkier debt, and it’s super levered up,” Stephen Blumenthal, chief investment officer at CMG Management Group, told Bloomberg. “When you get yields compressed to record lows, it takes more leverage to generate return. It’s classic human and end-of-cycle behavior.”
