(Bloomberg) -- Massive leveraged buyouts. An ever-growing pile of risky debt. Early signs that subprime consumers are falling behind.
It may not be 2007 all over again, but history is at least rhyming here. Then it was TXU Corp.'s $44 billion LBO, now its Electronic Arts Inc.'s potential $50 billion buyout. Then it was subprime mortgage bonds, now it's private credit, among other kinds of debt. Then subprime consumers were missing mortgage payments, now they're falling behind on auto loans.
There are some key differences between now and 2007. Banks are more heavily regulated and have larger equity cushions. Consumers haven't borrowed as much this time around. LBO firms are using more equity for buyouts. And it's not yet clear whether financial markets will ever see widespread losses from private credit.
But even if global financial crisis 2.0 doesn't come, investors may well be in for a rough ride in the coming months as frothy financial markets come to terms with a cyclical slowdown. Bonds and stocks that have gained in recent months could return to Earth. Risk premiums on US high-grade corporate bonds reached their tightest in 27 years earlier this month, and are still hovering close to those levels.
"With valuations this high it doesn't take much to bring some fear back into the market," said Bill Zox, portfolio manager at Brandywine Global Investment Management. But with the Federal Reserve cutting rates now, "the echoes of the financial crisis are faint."
Early Signs
Any signs of trouble in the economy are still early. The US unemployment rate in August rose to the highest level since 2021, while job growth cooled notably. A report on Friday said US consumer sentiment fell in September to a four-month low.
Debt markets have broadly grown fast over the last decade. The US high-grade market was less than $4 trillion in early 2015, and now has about $7.6 trillion outstanding. Private credit has evolved into a more than $1.7 trillion market relatively quickly.
"There are things every day that I see where I'm like, 'This is frothy,' but it's really hard to know how much contagion there will be from some of these clearly frothy headline events," said Hunter Hayes, chief investment officer at Intrepid Capital Management.
In recent months, a series of market watchers have sounded alarms about corporate debt markets. Jamie Dimon said in June that he wouldn't be buying credit if he were a fund manager. Jeffrey Gundlach, chief executive officer of DoubleLine Capital, said soon after that his firm had been cutting back exposure to junk bonds, because valuations don't reflect the risks. Josh Easterly, co-founder and co-chief investment officer of Sixth Street Partners, pointed to heavy risks in May.
The 2007 to 2009 global financial crisis was catastrophic for the global economy. Governments worldwide had to pump trillions of dollars into the financial system to prevent collapse. Analysts at the Federal Reserve Bank of Dallas estimated in 2013 that the crisis cost the US at least $6 trillion to $14 trillion in lost output, noting that lost consumption and other negative consequences of the downturn would probably bring that figure even higher.
Few expect that kind of outcome now. In fact, it's hard to know what model of past market tumult is best to use in considering risks now, said Christian Hoffmann, portfolio manager at Thornburg Investment Management.
"Every cycle is unique, every crisis is exceptional, and the winners and losers, though often similar, are certainly not the same," Hoffmann said, adding "When you price things to perfection, anything less than perfection can cause, at a minimum, a correction."
Week In Review
Oracle Corp. sold $18 billion US investment-grade bonds, the market's second-largest deal this year, making the software firm the latest to ramp up borrowing to fund investments for the artificial intelligence boom.
Ares Management Corp. has set fundraising targets for data center investments, positioning itself to capture a share of the millions of dollars in new fees flowing into the booming sector.
Some holders of Tricolor Holdings' asset-backed securities received interest payments, only to see the funds clawed back, after the subprime auto lender abruptly filed for bankruptcy.
Meanwhile, auto-part supplier First Brands Group LLC is preparing to enter bankruptcy with no restructuring plan in place, a sign of how quickly the company's fortunes are unraveling.
HSBC Holdings Plc took the unusual step of getting directly involved in pushing its Hong Kong subsidiary, Hang Seng Bank Ltd., to offload portfolios of bad real estate debt.
New World Development Co., the distressed builder at the center of broader property woes in Hong Kong, secured a HK$3.95 billion ($508 million) loan backed by its crown jewel asset in the city, falling short of the high end of its initial target.
China Vanke Co. is in talks with major domestic creditors to cut borrowing costs on private debt worth tens of billions of yuan.
A Goldman Sachs Group Inc.-led group of banks launched a $5.5 billion leveraged loan to help finance Thoma Bravo's pending acquisition of human-resources software provider Dayforce Inc.
Bonds backed by private credit loans are now among the hottest financial products on Wall Street with heavyweight firms like Blackstone, Apollo Global Management and Golub Capital selling them at the fastest pace on record.
Wall Street banks are in line to arrange more than $20 billion of M&A debt, as deal activity revives and their efforts to prise private equity rainmakers out of the arms of direct lenders starts to pay off.
Heineken NV sold €2 billion ($2.35 billion) of bonds to help finance its acquisition of Florida Ice and Farm Company's beverage and retail businesses.
Banks are asking investors to pay a premium to buy a loan to Belgium's Infra Group, another sign that red-hot credit demand is turning normal market conventions upside down.
Valentino SpA is in talks with creditors after a slowdown in demand for luxury goods battered its results, leading the fashion house to breach the terms of its debt.
A federal judge granted a group of big banks including Bank of America Corp. and JPMorgan Chase & Co. their bid to end a long-running benchmark-rate rigging case.
Braskem SA's dollar notes slumped on Friday after the company said it hired financial and legal advisers to find ways to improve its capital structure.
On the Move
Josh Harris' 26North Partners hired Matthew Manin, former head of private equity capital markets at Apollo Global Management Inc., as part of its capital-markets team.
Bank of America Corp. recruited Wall Street veteran Rob Milam as head of emerging markets credit trading and announced a string of appointments to boost its credit trading desk. Milam was previously head of emerging markets credit at Cerberus Capital Management.
--With assistance from Isabella Farr.
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