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As I have stated before, the CLOs, leveraged loan pools and the high yield CDOs insured by the monolines are going to be the media's new whipping boy once they figure it out. It is a much, much larger market than that of subprime, but showing the exact same characteristics borne from the "other people's money" underwriting methodology. Considering the amount of leveraged used by the monolines and the amount of losses stemming just from the real estate and mortgage related losses (we haven't even gotten to the CMBS and consumer finance losses yet), there may be relatively little capital left to handle the real deluge coming down the pike... Bailouts, or the lack thereof, here we come!  Remember, most of the prominent investment banks got stuck with many, many billions of this stuff on their balance sheet when the market woke up and realized they didn't want IOUs as as deb service payment from a company with a junk rating. The banks were taking big writedowns on these loans before these massive devaluations. What do you think they are going to take now?

From the High Yield Report ...
February Sees Surge Of High Yield Damsels In Distress
March 3, 2008

 The new year so far has brought more cuts in interest rates... It has also seen a rapid expansion of the distressed debt universe. More issues have found themselves locked in the tower of distressed debt, and there is no knight in shining armor on the horizon. Those sectors affected by slower consumer spending have been more likely to find themselves there, and this universe will likely continue to expand in the foreseeable future.

According to Standard & Poor's U.S. Distressed Debt Monitor report, published last week, the U.S. distressed bond ratio accelerated to 16.9% in February, which was its highest level since June of 2003 and a wide jump from its level of 1.0% the previous year (1,690%). Such debt is defined as speculative-grade credits that have option-adjusted spreads of more than 1,000 bps relative to Treasurys.

The leveraged loan market also saw a big advance in distressed issues in January. The S&P/LSTA Leveraged-Loan Index distress ratio increased to 6.9% in January, from 3.2% in December. This is the highest ratio since March of 2003. Issues in the distressed universe were worth $104.1 billion by the start of last week, a $40 billion jump from January, S&P reported.


The number of distressed bonds grew to 363 issues by Feb. 20, up from 298 at the end of January, according to high yield market researcher FridsonVision, which found that the distressed bond universe expanded by 22% for the first three weeks of February.FridsonVision cites the Merrill Lynch U.S. High Yield Distressed Index as being on track to show its eighth consecutive monthly increase in membership.

And bonds are increasingly entering the distressed realm despite the very low level of defaults. The U.S. speculative-grade default rate began rising this year, but is still low, having reached only 1.09% in January, according to S&P. "It seems remarkable to have this level of distressed [debt] when defaults are at a historic bottom and the economy is flat," said Margaret Patel, a portfolio manager with Evergreen Investments. "It tells you more about the poor quality of a lot of issues that were able to access the high yield market and tells you a lot about the marginal buyers." S&P expects the baseline high yield default rate to reach 4.6% by the end of 2008, while the high forecast is 5.7% and the low 3.4%.

The new additions to the distressed debt market over the past month include entrants from sectors such as gaming, real estate and electronics. "There were definitely a lot more names on there and from a lot of different industries. It's not just the home builders and the auto components space," said Joel Lutton, director of research with APS Financial Services...

... A quarter or more of all speculative-grade rated securities are now trading at distressed levels are in the retail and restaurants sector, in media and entertainment, and in consumer products, according to S&P. "The top three [sectors] that we're seeing pretty consistently involve consumer discretionary spending: media and entertainment; retail; and restaurants. With media and entertainment, when we look at the distribution of ratings, 80% of those are in the junk category...

The gaming sector saw several additions to distressed trading, including Station Casino. The Las Vegas company's 6.625% notes due 2018 joined the distressed list in February. Station Casinos has seen layoffs due to setbacks in income. It recently sold a 4.9% stake to Australian gaming company Crown Ltd. for $242 million. Last year, Station agreed to be acquired by Fertitta Colony Partners LLC for about $5.4 billion. And the company wasn't the lone gaming representative on the new distressed list; it was joined on the distressed list by bonds from Harrah's Entertainment, Jacob's Entertainment and three other companies. "I sense in gaming that there are going to be more issues than what people think," said a New England-based fund manager. He pointed out that capacity for gambling has grown substantially over the past several years, and that the sector faces serious losses now. "With people feeling the malaise in the economic environment, people aren't racing off to have a fun time at a casino. That business is going to struggle more than what people think."

Freescale Semiconductor's 8.875% bonds due 2014 also entered the distressed universe last month. Freescale's private equity owners are overhauling the company and recently named a new CEO to lead the highly leveraged chip maker. The microchip business, already considered cyclical, faces tough challenges in the current economic climate. Freescale agreed in September of 2006 to be acquired in a buyout deal by a private equity consortium led by TheBlackstone Group and including The Carlyle Group, Permira Funds and the Texas Pacific Group for $17.6 billion. The deal was the largest buyout ever for a technology company, and Freescale priced a $5.95 billion high yield offering two months later.

Hawaiian Telecom's 9.75% notes due 2013 also entered the distressed universe in February. The company is in the middle of a turnaround after suffering heavy losses. Since it was purchased by The Carlyle Group for $1.6 billion in 2005, the company has lost $137 million. Last week, Hawaiian Telecom announced that Stephen Cooper, the turnaround executive who took over Enron in the wake of its scandal, had taken over as the company's CEO (HYR, Feb. 11, 2008). In late January, the company laid off 50 managers, part of an effort to control costs that promises additional layoffs. The telecom services provider has lost revenue from its residential landlines as consumers turn increasingly to cable telephone service and cell phones. The company has also faced increased competition from cable and wireless Internet providers. Other telecom companies with bonds that recently entered the distressed universe are Alltel and Level 3 Financial, according to FridsonVision.

What most of these companies have in common, explains Patel, is that they are very highly levered and very much affected by discretionary consumer spending. She expects that the distressed universe will expand across all industries. "It's going to be the bottom tier from a whole range of industries, and it will be over-levered companies that shouldn't have been able to raise money," she said.

And those on the list will likely stay a while. Market observers expect the list of distressed bonds to grow over the course of the year. "There's a good portion of the high yield universe that's now in distressed. You'll see a lot of issues remain distressed for quite a while," said Josh Nahas, a senior analyst with Penn Capital Management. He noted that the workout cycle this time around would be longer than the last one in 2001...