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  • Writer's pictureTrevor Cooper FCISI

Naisbitt King Bond Commentary 1st April 2023

Updated: Oct 25, 2023

  • Credit Suisse troubles

  • U.S. regional bank problems

  • Mixed market performance

  • New issuance

  • Issue of note - investors put up $50bn for Johnson & Johnson spin-off

  • Nissan’s rating cut

This year so far is proving to be a dangerous for investors. However right from the start of March things got worse after American regional banks and Credit Suisse nearly collapsed.

In 2008 Royal Bank of Scotland, Lloyds TSB and HBOS all went bust, except they didn’t, the UK government rescued and resuscitated them. At the time RBS was, briefly, the largest bank in the world but it was almost fatally exposed to risky loans in the U.S. and exposed to risky investments that imploded. It was also part of a consortium of banks that took over Dutch bank ABN Amro in the largest deal in financial services history. To save the RBS the UK government injected sufficient money which meant it ended up owning 84.4% of the bank. Sure, the American government let Lehman bust go in 2008 but that seems unlikely to happen again – we hope.

The Swiss authorities didn’t see the rescue of Credit Suisse in the same way. The Swiss regulator FINMA changed its rules over a weekend to oversee a payment to Credit Suisse First Boston shareholders of $3.53bn, while $17bn worth of Credit Suisse AT1 contingent convertible (CoCo) bonds were completely wiped out. This was an unprecedented and unique situation as it turns the principal of equity holders ranking behind all debt holders on its head. The Swiss regulators actions could have long terms consequences for, particularly, the Swiss banking industry. It should be said that UBS CoCo bonds that have the same ‘Permanent Write Down’ language as the now worthless Credit Suisse CoCo’s, and remain trading well. Albeit at lower levels than before.

After the FINMA ruling, the ECB quickly confirmed the long held conviction that shareholders are indeed subordinate to debtholders. The Bank of England was fast to also repeat this principal which was then demonstrated in practice in HSBC’s rescue of Silicon Valley Bank UK. The FINMA decision will have far reaching consequences especially after the arranged shotgun wedding between UBS Group and Credit Suisse. Interestingly, UBS is more reliant for its capital on the type of risky bonds than any other major lender in Europe. AT1s are the equivalent of about 28% of the Swiss lender’s highest quality regulatory capital, while the average exposure among the 16 biggest banks in Europe is only about 16%.

U.S. regional bank problems

First there was Silvergate Capital that announced it was winding down, the first bank casualty from the cypto industry’s implosion. Then the shares of a major lender to fledgling companies, Silicon Valley Bank (SVB Financial Group), first dropped 24% in one day amid growing worries over its financial health as prominent venture capitalists recommended companies to withdraw their money. Its shares then fell further, much further. SVB’s massive failure is the second-largest bank collapse in U.S. history after Washington Mutual’s collapse in 2008.

The Federal Reserve, the Treasury Department and the Federal Deposit Insurance Corporation (FDIC) announced that SVB’s troubles posed a systemic risk to the financial system, allowing regulators to take the unusual step of guaranteeing the deposits up to $250k. Then, last week it was announced that a deal for SVB after the FDIC seized it. First Citizens Bank purchased $72bn of SVB’s assets which came at a $16.5bn discount. Roughly $90bn in Silicon Valley Bank’s securities and other assets were not included in the sale and remained in the FDIC’s control. SVB had roughly $175bn in deposits before its collapse, an illustration of how extensive the withdrawals were before it was seized by regulators.

Mixed market performance

After the initial drop in prices of all AT1 bonds we have seen the market recover somewhat. The Bank of England Governor, Andrew Bailey recently said, ‘the global banking system is more robust and better capitalised than in was in 2008, making a repeat of the crisis more than a decade ago unlikely’. There are many investors licking their wounds from their Credit Suisse CoCo and U.S. regional bank sector exposures, but last week saw the entire market stabilise.

Naisbitt King Asset Management is only invested in the debt of strongly capitlised international banks, therefore has never held Silvergate Capital, Silicon Valley Bank nor FRC Group debt. We also did not have any exposure to Credit Suisse credit. The question for us is how far does the fallout spreads around the world and what companies will be affected. Continued governmental support around the world has and will be vital.

New issues

Given the turmoil of the last few weeks its hardly surprising that companies, especially financials, took a step back from launching new debt. After a roaring start of the first 2 months of the year, the breaks were stamped on hard from the start of March. The March total volume of $100bn fell well short of earlier projections that called for $150bn. Financials still made up the biggest sector in the U.S. dollar with over $28bn issued in March. The good news was that almost all the U.S. high class new issues that did arrive, improved their prices in the secondary market by the end of the month.

Issue of note - investors put up $50bn for Johnson & Johnson spin-off

At the start of March one of the very few companies in the world that is still rated at an all AAA grade, Johnson & Johnson (J&J), raised a significant amount of cash from a new bond deal for its newly created subsidiary. In 2021 J&J announced its decision to spin-off its consumer health company following the trend of companies doing the same which included Merck, Sanofi, Pfizer and GSK. The name chosen for J&J’s spin-off health care arm was Kenvue Inc. To finance the separation from J&J, Kenvue announced a $7.75bn 8-tranche deal which generated a massive orderbook of $50bn. Interestingly, despite the inverted shape of the yield curve at the time the longest tranches were the most popular, with the 30 and 40-year tranches comprising one third of the entire orderbook.

At the resumption of primary insurance in the fourth week of the month, 7 companies brought deals, the largest of which was the $6.5bn 4-part bond deal for UnitedHealth Group which gained a $33bn orderbook at its height.

Other notable deals this month were $2.5bn issues for Hyundai and $3bn 4-part tranches each for Lowe’s Companies and Mercedes Benz North America.

Euro denominated bond sales have topped €500bn since the start of the year — the fastest rate on record as uncertainty over inflation and geopolitics pushed companies, banks and governments to issue bonds despite continuing high yields.

Nissan’s rating cut

The bizarre story of the Nissan’s former chairman, Carlos Ghosn’s Japanese arrest, and subsequent escape is still having its effect on the company. In early March the Japanese automaker’s credit rating was pushed by S&P into the sub-investment grade level of BB+ stable outlook, the first time the company’s history. S&P said in its report that a strong recovery in profit and sales was unlikely and cited persistent supply chain turmoil and high costs in the industry. ‘Nissan’s profitability will continue to lag its competitors for the next one to two years,’ S&P added. Supply chain issues will continue to delay any recovery in sales across the U.S. and Europe. Moody’s still rates Nissan at Baa3, stable. It should be said that the loss of investment grade status has not really affected the prices of its bonds which have looked cheap to the curve for some time.

The downgrade mentioned above, marks another blow for the carmaker that Carlos Ghosn attempted to turn into a global heavyweight by expanding its partnership with Renault and Mitsubishi Motors. His arrest five years ago in Japan on charges of financial misconduct ended those ambitions. Instead, the partnership has reversed course with the announcement in February that Renault will gradually reduce its stake in Nissan, leaving both companies to go their own ways.

Trevor Cooper FCISI

Chief Executive Officer

Chief Investment Officer

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