A cruel winter is coming for Wall Street as pandemic debts come due
A banker recently told me that CEOs ‘would have to do something pretty special to go bankrupt’ over the past two years as the government pumped massive liquidity into the market on top of pandemic aid .
That is changing, perhaps rapidly, with the Fed raising interest rates and shrinking the size of its balance sheet.
A cruel winter is likely for Wall Street as markets remain choppy and their biggest customers dwindle. Traditional transactions such as IPOs have declined significantly. At every major investment house, management is quietly planning layoffs (and some, like Goldman Sachs, not so quietly).
One area of potential growth: the restructuring of Wall Street departments. They are considering an expansion to provide guidance to companies so burdened with high debt that they have to sell things or “restructure” in the event of a Chapter 11 bankruptcy.
Sources tell me investment bank Morgan Stanley is considering a big expansion of its restructuring team (Morgan Stanley wouldn’t deny the case). Other banks are likely to follow because none of this is really rocket science.
If you think the Fed needs to raise rates significantly (which it does, given the latest inflation numbers), the economy will suffer. Recession is looming. It’s likely that some segments of corporate America have burdened themselves with cheap debt and will need help to avoid bankruptcy — or get out of it. This is becoming big business for Wall Street.
The unwinding of the credit cycle to tighter lending standards is always tough enough for corporate balance sheets, but it could be particularly brutal this time given the monetary policy experience – and corporate debt frenzy – of last two years and more, the bankers tell me.
Since the pandemic, even the most struggling businesses had access to credit. So-called leveraged transactions have exploded. Mergers and acquisitions often relied heavily on borrowing because the Fed provided so much easy money that the banks practically made loans.
What goes up eventually comes back to Wall Street. The easy money of the early 2000s paved the way for the financial crisis of 2007-2008 with mortgage debt at the center of deleveraging.
The easy money of the pandemic economy has led to similar risk-taking among businesses and investors. A denouement is guaranteed even if it is not yet clear if it will reach such cataclysmic levels.
Consider the leveraged loan market of over $1.4 trillion, which includes borrowings from the most indebted companies. This debt has doubled in just seven years. More troubling, the biggest share of the market jeopardizes loans to the riskiest credits. “Unwanted” credit now accounts for more than 28% of those loans, according to Morningstar data trackers.
You see where I’m coming from: as rates continue to soar, these borrowers will find it harder, if not impossible, to refinance their debt. Profit margins (if businesses are profitable) are reduced as the economy slows. This Gordian knot translates into lower stock prices, layoffs, and more. .
In the midst of this mess will be the restructuring departments of major banks providing advice and collecting fees for their time.
The good news
A few caveats to the catastrophic scenario. Restructurings are starting to pick up (see Revlon and Bad Bath & Beyond) but they are not making headlines as default rates remain low. The St. Louis Fed Commercial Banks All Delinquent Loans Index is a far cry from the highs reached just after the banking crisis.
But bankers say trouble looms when loan terms come to an end and so-called balloon principal payments come due. Those big numbers will start next year when more than $200 billion in leveraged loans will need to be refinanced and will increase every year by multiples until about $1 trillion is due in 2028, a banker tells me. .
That’s a lot of debt to refinance in the face of tighter credit conditions. It’s a recipe for recession, but also for making money by restructuring Wall Street stores.
As bad as inflation is, chances are it will get worse. A nightmare scenario is beginning to circulate among major investors on Wall Street.
It all started with BlackRock CEO Larry Fink’s grim assessment, explained in this column last week, that the Biden administration has fueled significant inflation through reckless spending. It is now almost impossible for the Fed to stage a “soft landing” for the economy with inflation at 8.3%.
Still, it could get worse. Global droughts and the continued war in Ukraine are resulting in lower crop yields and higher food prices. Gas prices could fall, but the administration seems determined to keep them high by canceling drilling permits. As workers demand higher wages (and railroad workers got one last week by threatening a strike), Fed Chairman Jerome Powell is raising interest rates until the economy s collapses.
Dark stuff that some pundits dispute, many of the same geniuses who said inflation was “transient.”