Yeah, This is Going to End Well

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You know, when I read the headline, “Wall Street Finds New Way To Finance Unprofitable Tech Firms, I have a feeling of impending doom.

I know that there are cartoons to explain the process, so it does not invoke Saroff’s Rule, “If a financial transaction is complex enough to require that a news organization use a cartoon to explain it, its purpose is to deceive,” but this sounds like it’s another crack-up waiting to happen.

They are called Asset Backed Secularizations, and every sentence seems of the article implies greater and greater leverage and greater uncertainty:

No earnings? No problem. Investors are funneling money to unprofitable software companies through a new type of debt deal.

Nonbank lenders like Golub Capital, AllianceBernstein Holdings LP and Owl Rock Capital Partners LP have issued asset-backed bonds to help finance about $2 billion of loans to such companies since November, according to data from Kroll Bond Rating Agency Inc. and S&P Global Market Intelligence. Many of the loans are to fast-growing, but still unprofitable, software enterprises.

………

The loans backing the complex bonds—known as asset-backed securitizations, or ABSs—can be small, like the $25 million Golub provided to software delivery specialist CloudBees Inc. Other deals run in the hundreds of millions of dollars, like the $300 million Owl Rock lent to back the leveraged buyout of software security company Checkmarx by private-equity firm Hellman & Friedman LLC. Golub has been making the loans since 2013 and has had no defaults, even during the pandemic-induced economic downturn last year, according to a credit-rating report.

………

Still, some fund managers say the new deals pile debt on debt, disregarding the risk of default in the relatively immature companies.

Demand for ABS backed by conventional corporate loans called collateralized loan obligations, or CLOs, surged late last year as markets recovered from the pandemic selloff. But, the new transactions are so unorthodox that large credit-rating firms Moody’s Investors Service and Standard & Poor’s Global Ratings don’t rate most of them, the people involved said.

Instead, the bulk of the deals have gotten ratings from Kroll Bond Rating Agency, one of three smaller firms competing with Moody’s and S&P for credit-ratings business.

………

A single investment bank, MUFG Securities Americas Inc., has arranged all of the deals for the lenders, selling them primarily to U.S. investors specializing in ABS, the people said. A spokeswoman for MUFG, a subsidiary of Japan’s largest bank, Mitsubishi UFJ Financial Group Inc. declined to comment.

………

The average credit quality of the loans is the equivalent of debt with a single-B or triple-C rating, two of the lowest rungs on the credit-rating ladder, according to research by Kroll. If the borrowers default, it is unclear how much lenders will recover. “It is a relatively new asset class with limited recovery data,” Kroll said in a report.

 Let’s see:

  • Obscure financial product.
  • Single ratings agency participating.
  • Single bank arranging the deals. 
  • Junk bonds (anything less than BB+ is a junk bond)

Bingo!

This is going to blow up.

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