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  • Trevor Cooper FCISI

Naisbitt King Bond Commentary 1st August 2022


  • Caution from high yield primary borrowers

  • Issuance follows the American bank results

  • Elon Musk’s trials and tribulations

  • Alibaba facing expulsion from U.S. exchanges

  • EDF nationalisation

  • PepsiCo Inc issues in dollars and sterling

  • SSE PLC launches its first European euro denominated green bond in 4 years

  • General Motors also launches green bonds but in dollars

  • Nationwide launches a successful sterling ‘covered’ floating rate bond

  • Californian wildfires bond

  • Croatia upgraded ahead of adopting the euro currency



All our portfolios have gained ground in the last month, and we see this trend continuing in what has been a difficult year for all markets. As everybody knows global markets have been shaken over recent months by the many concerns of rising inflation, increasing interest rates, weaker economic growth, Russia’s invasion of Ukraine and of course the ongoing threat of the Covid virus, causing a selloff in most markets. We have been steady in our investment strategy this year as we believe this selloff in credit markets has been largely overdone. As I have outlined before default rates are low and, in major regions, are set to remain so. We remain confident of corporate fixed income given the continued strength in company balance sheets. We have seen solid bank results in the last couple of weeks and better-than-expected earnings from the tech sector this week.


Are credit markets on the turn? July was an extraordinary month, it saw the 10-year Treasury bond hit a three and a half year high yield of 3.50%, before dramatically turning to end the month at 2.65%, a level last seen in April. Mirroring the Treasuries, the yields of UK gilts and German bunds also backed off recent highs to radically decline. The 10-year gilt now yields 1.86% and the bund 0.81%. Last week’s decision from the FOMC to raise their rate by an expected 75bps seems to have calmed rate markets. The curve between the 2 and 10-year Treasuries remains deeply negative in a worrying sign for the economic outlook and a higher risk of recession. Sentiment certainly improved after the Fed meeting. The market took heavy new issuance, especially in financials, in its stride.


The euro is now on par with the dollar, a level not seen since the early 2000’s. How much this is dollar strength, which has outperformed all the other ‘Group-of-10’ currencies except for the Japanese yen, cannot be known perhaps? This month the euro has also underperformed sterling. Many market commentators believe the sterling-dollar rate, currently at 1.22, could see a low of 1.15 but not below


Caution from high yield primary borrowers


The annual summer lull combined with steadily deteriorating macro-economic conditions and recession fears kept high yield bond borrowers on the side-lines, with the month-to-date supply at a modest $1.84bn, the slowest July since 2006. The year-to-date high yield bond sales were at $68.8bn, the lowest since 2008.


Issuance follows the American bank results


The same slowdown of issuance can’t be said of the U.S. high grade market. The American bank results season last month ended with several major players rushing to launch large amounts of fresh debt. Bank of America, JPM, Morgan Stanley and Wells Fargo all launched large successful multi-tranche dollar deals after their figures. These banks sold $27.5bn between them of senior unsecured fixed to floating bonds, far more than was expected. At the beginning of the month the market was forecasting around $15bn from the major banks.


We have been keen on bank debt, especially American, for a long time and always had an overweight position in the sector for our portfolios. Global interest rate increases have made bank core lending businesses more profitable. Despite a possible recession around the world, we are not seeing any signs of stress in financials. All the bonds have performed very well since launch.


Unlike the high yield market, this year the wider high grade U.S. new issue market is running just 6% behind last year total at this point with $803bn so far launched.


Elon Musk’s trials and tribulations


Elon Musk’s on/off/on/off $44bn deal for Twitter has not affected the credit bond market. ElonMusk's original financing package for Twitter which comprised of $21bn in cash and $12.5bn of margin loans secured against his 16% stake in Tesla, together with $13bn in loans from a consortium of banks. These days Tesla has no public debt besides a small $46m convertible. Twitter has little public debt beside some convertible bonds amounting to around $2bn nominal and $1.7bn nominal in 2 fixed rate bonds. Unlike the equity of both companies, which have traded lower, the debt has hardly moved. Last week Tesla published its 10-Q filing, releasing more details about the cost of its bitcoin bet and its ongoing fallout from CEO Elon Musk tweeting that he was considering taking Tesla private. The company recorded a loss of $170m resulting from changes to the carrying value of its bitcoin. Tesla also said that it still holds $222m of ‘digital assets’ after selling $936m in bitcoin.


Alibaba facing expulsion from U.S. exchanges


Alibaba has been added to the American SEC list of Chinese firms facing delisting as American inspectors are not able to access financial audits. The U.S. watchdog is cracking down on New York-traded firms with parent companies based in China and Hong Kong. Alibaba would be by far the largest Chinese company to get kicked off US stock exchanges if regulators failed to strike a pact. The company has argued that, since its 2014 New York IPO, its accounts have been audited by globally accepted accounting firms and should meet regulatory standards. This year Alibaba’s shares have dropped 25% but, whilst trading lower, its bonds are dealing lower they are in line with their U.S. peer group. We will be closely watching developments with the situation going forward. None of our portfolios have Alibaba bonds.


EDF nationalisation


France has taken the decision to fully take control of Electricite de France (EDF). France currently it owns 83.9% of the energy producer. The French government offered to pay about €9.7bn ($9.9bn) to fully nationalize EDF as it seeks to resolve problems at the power generator that are exacerbating Europe’s energy crisis.

Moody’s and S&P have been progressively lowering their ratings on EDF over the last few years, so it will be interesting to see their reaction to this full nationalisation. At the moment EDF is rated at Baa1/BBB/BBB+, all negative. EDF shares have powered ahead by some 40% since the announcement, it has also been positive for its bonds.


PepsiCo Inc issues in dollars and sterling


PepsiCo launched debt in dollars and, for the first time in 10 years, sterling. PepsiCo launched bonds in sterling, a £300m 7-year and £400m 12-year. Proving very successful, these bonds attracted a strong orderbook of £2.75bn. PepsiCo also launched a $2.5bn dollar deal which included a rare green tranche, usual in non-financial companies. PepsiCo issued 5, 10 (green) and 30 year senior unsecured bonds. The company saw a strong orderbook which grew to $14.5bn, with good interest in the longer maturity tranches. PepsiCo senior debt is rated A1/A+, both with stable outlook. All the new tranches have been successful in the in the secondary market especially the 30-year dollar bond which has tightened some 20bps as did the 2034 sterling issue.


SSE PLC launches the first European euro denominated green bond in 4 years


We saw significant demand for SSE Plc’s new euro denominated green bond, which could tempt other companies to bring debt deals to market. SSE, based in Perth, Scotland, saw investors create an orderbook of near €5.85bn, nine times the size of its €650m deal. The deal was the first green offering in the region’s common currency since 2018. Strong demand enabled the company to cut the spread on the deal to 120bps above mid-swaps from an initial target of about 155bps. The offering is a boost to what’s been a sporadic run of non-financial issuance recently amid concern about the general global economic outlook. The senior unsecured 7-year bond, which is rated Baa1/BBB+/BBB+, all stable, has a coupon of just 2.875%. The successful bond is now trading over 2.5 points higher since launch.


General Motors also launches green bonds but in dollars


General Motors (GM) sold environmentally friendly bonds for the first time ever last week, joining its competitors in tapping the sustainable debt market to fund the transition to electric vehicles to compete with Tesla. GM priced $2.25bn of green bonds with maturities of 7 and 10-years. The longest portion of the offering, a 10-year security, yields 295bps above Treasuries, after initial discussions of as much as 320bps. The $2.25bn deal it is the second-largest green deal from a U.S. corporation outside of the financial sector. Despite senior investment grade securities GM had to pay 5.4% and 5.6% respectively for their borrowings. Both bonds are trading flat to their issue spreads since launch.


Ford, Toyota and Honda have all bought green bonds to also fund their transitions to electric vehicle research.


Nationwide launches a successful sterling ‘covered’ floating rate bond


A couple of weeks ago Nationwide Building Society was able to launch a sterling indexed bond. Nationwide, the world’s largest building society, which has a high Common Equity Tier 1 (CET1) ratio of 24.1% and is one of the strongest financial institutions in the UK, and possibly the world. The issue couldn’t be said as a runaway success as the £1.5bn note only had a book of £1.7bn. This bond is a ‘covered bond*’ with a AAA/AAA rating, which means it is rated above that of index-linked UK gilts which is rated Aa3/AA/AA-. The UK mutual also launched a $850m 4.85% 5-year senior preferred bond rated A1/A+/A+, all stable. Again, a successful issue which was tightened 20bps to +170bps over Treasuries during the book build. The bond is now trading on a spread of +158bps.


*The underlying loans of a covered bond stay on the balance sheet of the issuer. Therefore, even if the institution becomes insolvent, investors holding the bonds may still receive their scheduled interest payments from the underlying assets of the bonds, as well as the principal at the bond’s maturity. Because of this extra layer of protection, covered bonds typically have AAA ratings.


Californian wildfires bond


The Californian wildfires of late 2018 not only wreaked havoc, with 459k acres of forestry lost, but sent the bonds of Pacific Gas & Electric (PG&E) utility company plunging as their equipment was accused of actually starting the fires. As we see more Californian wildfires breaking out this year, PG&E raised $3.9bn, up from $3.25bn, with new a Wildfire Recovery Funding* deal. PG&E launched a 5-part with maturities raging from 9 years to 30 years. These Wildfire bonds are rated Aaa/AAA. Since launch all tranches have done well with all spreads tightening.


*PG&E Wildfire Recovery Funding LLC, the issuer, is a bankruptcy remote, wholly owned subsidiary of PG&E and is formed solely to purchase and own the recovery property and issue the recovery bonds. PG&E, a subsidiary of PG&E Corp. ('BB-'), is a public electric and gas utility operating in northern and central California. The company serves approximately 10m consumers (including 5.6m electric service consumers) across a 70,000-sq.-mile service area in northern and central California. PG&E will be the initial servicer of the bonds.


Mexico, Pemex and Turkey downgraded


The United Mexican States was downgraded by Moody’s last month. The agency lowered the country’s rating by one notch to Baa2 with a stable outlook. Moody’s cut Mexico’s rating by one notch as it expects weak investment prospects and increased structural rigidities to constrain activity in Latin America's second-largest economy.


Perhaps unsurprisingly Moody’s followed Mexico’s rate cut with one for Petroleos Mexicanos (Pemex). The state oil company’s rating was lowered one level to B1 from Ba3, and the outlook was revised to stable. Last week Pemex reported a record profit in the second quarter of 131.5bn pesos ($6.45bn) as international oil prices surged, even though crude output continued to wane. Thanks to the price rally, Pemex said it will keep making its own debt payments as it no longer needs the government to do so for the rest of the year.


Mexico’s America Movil reported second quarter profits down 68% compared to the same period last year, citing higher interest payments. Moody’s and S&P had differing ideas for the company. Following their downgrade of Mexico itself, Moody’s also downgraded America Movil’s senior debt from A3 to Baa1 stable. S&P went in the opposite direction with their BBB+ rating rising to A-, again stable. Almost to prove a point America Movil launched a 10-year, fixed to floating, bond a couple of weeks ago. The $750m senior bond has a fixed 4.7% coupon, a final maturity of July 2032. Like so many issues launched this month this America Movil bond has performed well, tightening 18bps.


Fitch downgraded Turkey one notch from B+ to single B with a negative outlook. In a statement Fitch wrote ‘Guided by political considerations, the central bank has maintained its policy rate at 14% since December 2021, despite rapidly rising inflation, the impact of the war in Ukraine on commodity markets and tightening monetary policy in most advanced economies,’. The Central Bank of Turkey has kept its policy rate unchanged this year even as annual inflation surged to 78.6% in June. Consequently, the country has the lowest real yield in the world at minus 64.6%. Four year Turkish debt now yields around 10%. Elsewhere Turkey is rated B2/B+ both negative.


Croatia upgraded ahead of adopting the euro currency


Croatia was upgraded to investment grade by Moody’s, S&P and Fitch in July. Moody’s and S&P raised the Southeastern European country by two notches from Ba1 to Baa2 and BBB- to BBB+, both with a stable outlook. Fitch raised Croatia one notch to BBB+, also stable.


The country was upgraded as it cleared the last hurdle to its entry to the eurocurrency on 1st January 2023. S&P noted that as a member of the eurozone currency Croatia, which became a member of the EU in 2013, will benefit from the monetary policy flexibility of the European Central Bank, while residual foreign exchange risks will decline in the heavily euro based economy. Croatia's near-term economic prospects are seen as steady thanks to expected solid tourism flows and strong near-term execution of EU-funded investments. Croatia’s ratings are now Baa2/BBB+/BBB+, all stable.


Defaults


Default levels remain at very low levels. However, $500bn of distressed debt is threatening to drag the developing world into a historic cascade of defaults, especially in Emerging Market debt. Sri Lanka was the first nation to stop paying its foreign bondholders this year, burdened by unwieldy food and fuel costs that stoked protests and political chaos. Russia followed in June after getting caught by sanctions.


Now Argentina, Lebanon, El Salvador, Ghana, Egypt, Tunisia, Pakistan and others, are all trading in distressed territory and in danger of possible default.

Naisbitt King Asset Management does not have exposure to any of these possible defaulters.



Trevor Cooper FCISI

Chief Executive Officer

Chief Investment Officer

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