%1

Moody’s Investors Service warned that credit investors who’ve plowed billions of dollars into private-equity-sponsored LBO debt will be hit hard when the credit cycle turns and defaults rise, Bloomberg News reported. The giants of the PE world have used their imposing status to loosen terms on the bonds and loans they sell to yield-hungry investors, says Neal Epstein, a senior credit officer at Moody’s. That gives them more room to preserve their investments in a downturn — even if it means losses for creditors. Debt issued by large private-equity firms features few of the lender protections once typical of junk-rated debt, Moody’s said, such as the right to limit cash distributions or additional debt incurrence. That means that when these companies default, debtholders have little recourse to protect their investments. The largest PE firms have enough influence over lenders to maintain control of their assets while in default, Epstein wrote, and — perhaps most significantly — to engineer distressed-debt exchanges, which can preserve their own equity positions while saddling creditors with losses.

Fidelity Investments is cutting out its middleman — Goldman Sachs Group Inc. — when dealing with Wall Street short sellers, Bloomberg News reported. The money manager is bringing its stock-lending business in-house, according to a March 29 regulatory filing, instead of paying Goldman Sachs to run it. According to filings, the bank received about 10 percent of the revenues generated by Fidelity’s lending, primarily to firms that borrow stocks to bet against them. Fidelity, which managed $2.7 trillion of assets in March, plans to use some of the savings from the switch to boost returns in the funds that lend securities, particularly index trackers that hold thousands of different stocks. The move comes as Fidelity and its rivals compete to cut fees on index funds, luring assets that can be used for more profitable businesses like securities lending, industry analysts say.

U.S. regulators are monitoring how risk in the $1.2 trillion leveraged loan market is evolving and its potential impact on the U.S. economy, Reuters reported. Years of low interest rates coupled with increasing demand from investors for floating-rate loans allowed companies to borrow cheaply on looser documents, leading to outcries from Senator Elizabeth Warren (D), former Federal Reserve (Fed) Chair Janet Yellen and Mark Carney, Governor of the Bank of England. Warren, a Democrat running for President, wrote to regulators last November asking about their plans to address “growing risks” in the leveraged loan market, comparing the asset class to the pre-2008 subprime mortgage market, which contributed to the financial crisis. The Fed, the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corp (FDIC) responded to Warren in a February 25 letter that was not issued publicly, acknowledging her concerns about the growth in leveraged lending, which has led to weaker lender protections. “Agency examiners have observed in some transactions fewer and less stringent protective covenants, more liberal repayment terms, and incremental debt provisions that allow for increased debt that may inhibit deleveraging capacity and dilute repayment to senior secured creditors,” Comptroller of the Currency Joseph Otting, Fed Chair Jerome Powell and FDIC Chair Jelena McWilliams wrote in the letter.

Warren Buffett’s Berkshire Hathaway Inc. yesterday said that a $377 million charge it incurred recently was tied to a solar generation company that U.S. authorities have linked to fraud, Reuters reported. Berkshire said in its first-quarter report on Saturday it had invested $340 million in various tax equity investment funds from 2015 to 2018, before learning that federal authorities had alleged “fraudulent income conduct” by the funds’ sponsor. “We now believe that it is more likely than not that the income tax benefits that we recognized are not valid,” and took the charge for “uncertain tax positions” related to its investments, Berkshire said.

The Federal Reserve is further amplifying its warnings about the perils of risky corporate debt, saying in a Monday report that the market grew 20 percent last year and that lending standards continue to slip, Bloomberg News reported. In a particularly striking sign, the Fed said the businesses with the biggest existing debt loads are also the ones taking on the riskiest loans. And protections that lenders include in loan documents in case borrowers default are eroding, the U.S. central bank said in its twice-a-year financial stability report. The Fed board voted unanimously to approve the document. “Credit standards for new leveraged loans appear to have deteriorated further over the past six months,” the Fed said, adding that the loans to firms with especially high debt now exceed earlier peaks in 2007 and 2014. “The historically high level of business debt and the recent concentration of debt growth among the riskiest firms could pose a risk to those firms and, potentially, their creditors.” Since last year, the Fed has been highlighting the increasingly weak standards in leveraged lending — the loans that often underpin mergers and acquisitions involving highly indebted companies. Still, default rates have been low amid a booming U.S. economy.

The Securities and Exchange Commission is playing an increasingly important role in discussions of economic stability as the share of nonbank lending rises, the agency’s chairman, Jay Clayton, said yesterday, MorningConsult.com reported. The growth of collateralized loan obligations (CLOs), in particular, is one of the primary nonbank lending issues “on the table recently” for discussion, Clayton said. He said that the SEC is studying CLOs, single securities backed by a pool of debt, which often have a low credit rating. “Even if we conclude that the growth in CLOs is not something that poses a systemic risk, having those discussions among market regulators and banking regulators is a really big thing,” Clayton said. About two-thirds of CLOs are held by nonbank investors, according to the Financial Stability Board. Nonbanks such as mutual funds, hedge funds and asset managers are increasingly controlling debt marketplaces and lending. According to Federal Reserve research, this growth in lending among nonbanks came after post-financial crisis legislation requiring large banks to meet high standards for the amount and quality of capital on their balance sheets. The Financial Stability Board estimates that banks’ share of global financial assets had fallen to 39 percent in 2018 from 45 percent in 2008, while nonbank lending had grown to 31 percent from 26 percent in the same time period.

When Payless ShoeSource emerged from bankruptcy protection in August 2017, the national discount footwear company vowed to reinvent itself. But today the retailer and a hedge fund that controls it are locked in a contentious battle over its second turn through bankruptcy, USA Today reported. In February, just a year-and-a-half after its first chapter 11 reorganization case, Payless landed back in bankruptcy court — this time wiping a decades-old retailer off the map in the U.S. and Canada. The turn of events has destined an estimated 16,000 workers for unemployment and disappointed consumers who relied on the chain's 2,500 stores and website for affordable shoes, boots and sandals. The company intends to keep Payless' overseas operations running. Some of the chain's lenders and creditors claim the collapse may stem in part from self-inflicted causes. They cite the role of Alden Global Capital, a prominent hedge fund that is Payless’ majority shareholder as well as a major lender. Critics maintain Alden has invested in distressed companies and then in some cases installed unseasoned executives who cut costs and sold assets while failing to take steps needed for successful corporate turnarounds. Some Payless creditors and lenders also have raised questions about what they characterized as conflicts of interest between Alden and Payless. After hearing Alden-focused court arguments last Wednesday in St. Louis, Missouri, Chief Judge Kathy Surratt-States of the Eastern District of Missouri ordered anti-conflict-of-interest measures to ensure that Payless creditors and lenders receive equal treatment with the hedge fund. The provisions include the unusual appointment of a monitor to oversee the five-seat Payless board, three with Alden ties, including Heath Freeman, the hedge fund president.

A unit of online lender Prosper Marketplace Inc. agreed to pay $3 million on Friday to settle claims that it miscalculated returns of investors who funded its consumer loans, the Wall Street Journal reported. The Securities and Exchange Commission said Prosper provided inaccurate return data to over 30,000 investors between July 2015 and May 2017. The returns that investors saw on their account pages were wrong because they excluded defaulted loans from the calculation, the SEC said. The settlement comes three years after the SEC’s former chairman, Mary Jo White, said regulators were closely monitoring the accuracy of information that online lenders provide to investors. Another online lender, LendingClub Corp., settled allegations in 2018 that one of its units inflated returns and misused investor money.