Extend and Pretend: Hitting the Maturity Wall
How long can the government continue to Extend & Pretend? How long can public policy endlessly 'kick-the-can' down the road without addressing the underlying causes? Such a critical point is often academically referred to as a 'Tipping Point' or what newsletter writer John Mauldin refers to as a 'Finger of Instability'. I am more pragmatic and as an investor, who is forced to call the timing, I call it the Maturity Wall.
In a recent article entitled "Sultans of Swap: Fearing the Gearing!" I outlined the growing amount of debt that will need to be refinanced and rolled over in the coming years. Since releasing that analysis the amount may have reached a level where the Maturity Wall will be too high to be scaled. That level potentially identifies the critical requisite timing for investors to be fully aware of.
According to Morgan Stanley, as outlined in a December article by Malcolm Maiden of the Brisbane Times, the debt Maturity Wall looked like the following:
2010 2011 2012 2013 2014 TOTAL COMMERCIAL REAL ESTATE 552 560 537 480 459 2.7T LEVERAGED BUY-OUT DEBT 71 113 203 294 406 HIGH YIELD DEBT 35 64 75 82 126 TOTAL 657 737 815 856 992 4.2TSOURCE: Morgan Stanley, Fixed Income Research & Economics (1)
The Morgan Stanley, Fixed Income Research & Economics (1) indicated at that time the US will require $4.2 TRILLION in new financing to accommodate loans of questionable viability, existing lending terms or loan to collateral value coming due.
HIGH YIELD DEBT
On Monday March 15th Diane Vazza, head of global fixed-income research at Standard & Poor's was quoted as saying "many companies whose debt matured in 2009 and 2010 have been able to extend their loans, but the extra breathing room is only adding to the bill for 2012 and after. That is because the record number of bonds and loans that were issued to finance those transactions typically come due in five to seven years"(2)
The New York Times in "Corporate Debt Coming Due May Squeeze Credit states that the "result is a potential financial doomsday, or what bond analysts call a Maturity Wall. From $21 billion due this year, junk bonds are set to mature at a rate of $155 billion in 2012, $212 billion in 2013 and $338 billion in 2014."(2)
If we compare the current results to those reported by Morgan Stanley in Q4 2009 we are struck with the magnitude of the problem.
The chart to the right graphically represents the Maturity Wall associated with the High Yield debt line item alone.
What about the recently announced US Government debt financing needs? Also Investment grade debt? Based on what has been reported only after a few months since Morgan Stanley issued their report, I minimally calculate the hurdle bar to be the following (without being able to add reliable Investment Grade debt figures for 2013 and 2014):
|INVESTMENT GRADE DEBT||526|
|COMMERCIAL REAL ESTATE||552||560||537||480||459||2.7T|
|LEVERAGED BUY-OUT DEBT||71||113||203||294||406|
|HIGH YIELD DEBT||35||64||155||212||338|
|US GOVERNMENT DEBT||1800||1400||1400|
This table is also limited to the USA. The obvious question is whether there is sufficient global savings to accommodate this amount of US refinancing demand, plus the additional demands for the rest of the world?
There is little doubt it is going to be an Olympic record pole vault, attempted by then, a very weary, debt challenged athlete!
US GOVERNMENT DEBT
What has surprisingly received little media attention is that the US Government has been steadily reducing the maturity of its treasury portfolio to keep fiscal deficits down. Whether interest rates rise or it becomes a problem for the US Treasury to re-fund the ever expanding roll-over pools, both suggest a Maturity Wall is dead ahead. It will occur no later than 2012, but will likely be triggered with the next financial default scare.
"The world does not have so much money to buy more US Treasuries."
EVERYONE HAS GONE SHORT DURATION
The chart to the right is very instructive in showing both the level of Interest Rate Swaps with durations less than one year and the rate at which this duration has grown over the last ten years for US banks.
We now have $75T in Interest Rate and Foreign Currency Swaps in paper with less than 1 year duration held by US Commercial banks. When interest rates begin to rise towards Morgan Stanley's 2010 estimate of a 5.5% 10 Year US Treasury, watch out! You can expect dramatic market actions when $75T in derivative instruments starts re-adjusting.
INTEREST RATE SWAP INVERSION GIVING US YET ANOTHER SIGNAL
"Historically, yields on government bonds have traded at a discount to the derivative as swaps are money market instruments whereas Treasuries reflect triple A sovereign risk. Funding a swap trade over time is more expensive than Treasuries, but constraints on balance sheets make it difficult for traders to implement such trades. Swap rates and Treasury yields have been converging in recent weeks, driven by high government bond supply, and increased demand by investors using swaps for meeting long-dated liabilities rather than committing capital to buying bonds. (7)
Morgan Stanley says it's about SUPPLY, SUPPLY, SUPPLY. That is the SUPPLY of ON-Balance Sheet US Treasuries and the lack of SUPPLY from Off-Balance Sheet (Shadow Banking - SIV) LIBOR.
"The issuance of UST debt is dwarfing Libor-related issuance. For example, we expect UST net issuance to be $1.7Tr and net issuance of MBS to be zero. Thus, the relative issuance of UST's vs. Libor-based products mainly accounts for the inversion in swap spreads. This is a first sign of stress leading to higher UST yields and is not to be missed." (9)
BUT IT IS MORE THAN JUST A SUPPLY / ROLLOVER PROBLEM (as if that is not bad enough)
Let's further consider that interest expense would be about 80% of the entire budget deficit of fiscal 2011." (4)
With $492 Trillion outstanding in the notional value of global Interest Rate Swaps it is reasonable to conclude that, since one party on either side of these counterparty trades WILL GET HURT when rates rise, there is going to be a lot of hurting in a total global economy of only $45 Trillion.
All indications are that by 2012 the global economy is going to run headlong into a funding wall.
Markets always anticipate events at least 6 months in advance. This wall is so huge I doubt the market will wait and likely will begin adjusting 12- 14 months ahead!
All bets are off if we get another sovereign or possible US State surprise. This would move our Maturity Wall even 'closer in'.
The last Extend & Pretend article: EXTEND & PRETEND - An Accounting Driven Market Recovery
(1) 12-16-09 Wall of debt a barrier to US recovery - The Brisbane Times, Malcolm Maiden
(2) 03-15-10 Corporate Debt Coming Due May Squeeze Credit New York Times - Nelson Schwartz
(3) 03-04-10 Corporate Debt Coming Due May Squeeze Credit Gordon T Long
(4) 03- 27-10 Deficits And Debt-Financed Government The Market Ticker Karl Denninger
(5) 03-31-10 Are There Signs From The Bond And Swap Spread Markets That Government Debt Risks Will Derail The Expansion? - Zero Hedge
(6) 03-27-10 What does the Greek Debt Crisis Mean for you? John Mauldin
(7) 03-23-10 Swap rate falls below 10-year Treasury yield Financial Times
(8) 03-29-10 Strategic Outlook: Greece, Negative Swap Spreads, Near-Term Caution In Europe, MBS Spreads And More Zero Hedge
(9) 03-27-10 More Than Meets The Bottom Line: Are Banks Getting Crushed Due To Negative Swap Spreads And The $154 Trillion IR- Derivative Market? - Zero Hedge
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