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  • Writer's pictureTrevor Cooper FCISI

Naisbitt King Bond Commentary 1st May 2023

Updated: Oct 25, 2023



  • Positive signs for bank AT1 bonds

  • Bed Bath & Beyond goes bust

  • First Republic Bank shares and bonds fall further

  • Italy could lose its investment grade rating

  • Many U.S. regional banks are downgraded by Moody’s

  • New issue shortfall this year

  • Inflation-linked gilt issue gets record orderbook

  • Walmart sees a massive $46bn offered for it new bond

  • Big American banks rush to issue new debt after the SVB debacle

The recent banking issues were a painful event for many investors, but we are pleased to report that we were just observers. We do remain vigilant of the aftershocks along with opportunities this may bring. There is no question that inflation is still the elephant in the economic room in most countries, but there are signs of inflation moderating globally which should be positive for fixed income markets but talk of recession has not gone away. Central banks are still in rate increasing mode, but it does seem we are close to the top of the inflation curve. Financial stability concerns are subsiding which should keep Federal Reserve officials more focused on economic data at the meeting in two days. Deposit outflows substantially steadied by the end of March. The need for any emergency bank liquidity now seems to have peaked. Recent results from the banking sector have shown that most banks have seen strengthening fundamentals, which was also highlighted by recent rating agency actions. Barclays, Commerzbank and NatWest have all had their ratings upgraded.


The junior subordinated market is seeing the first signs that it may not be the no-go area it looked to be after the $17bn write-off of Credit Suisse’s AT1 notes. Firstly, Sumitomo Mitsui came with a Japanese yen deal followed by Mitsubishi UFJ. Secondly, towards the end of the month came the news that UniCredit SpA and Lloyds Bank, were repaying their AT1 bonds, which should be positive for the sector overall.


First Republic Bank shares have been halted following a report from CNBC that the most likely outcome of rescue talks is for the Federal Deposit Insurance Corp. to take the lender into receivership. Since the beginning of March First Republic’s shares have fallen 97%! Unsurprisingly it’s near $1bn of debt has also collapsed and is trading at less than 12.00, down from 80.00 in early March. Until the beginning of March, the banks senior ratings were A-/A-/A- before being severely downgraded.


Bed, Bath and Beyond


As a demonstration that investors need to be always vigilant as even the most well managed companies can change very quickly. Our investment processes had always ruled us out from buying Bed, Bath and Beyond (BBBY). It is an interesting, and depressing, story.


Since peaking at nearly $81 a share, giving a market capitalisation of over $13bn, in 2014, BBBY stock has lost almost all its value. While it withstood competition from Amazon and its like, its ultimate demise was due to a self-imposed disastrous management mistakes. In 2019, activist investors won control of its board and hired a new CEO, Mark Tritton, who then forced the retailer into the private-label strategy, that he had successfully devised for Target, on BBBY leaving customers unable to find good they needed. Now BBBY said it will close all its stores and liquidate inventory over the next two months after its turnaround failed. The company’s demise has been progressive with its shares falling from $30 in 2021 to worthless now. Likewise, its around $1bn of bonds, which were rated at an investment grade level in 2019, have now defaulted.


Ratings


Moody’s thinks the only country it covers that is at risk of losing its investment-grade rating is Italy. In a report surveying how nations have dealt with downgrades to junk over the past three decades, the euro zone’s third-biggest economy was highlighted as a prominent candidate for such a grading downgrade. No timetable for this happening was given. ‘Italy is currently the only Baa3-rated sovereign with a negative outlook,’ wrote Moody’s analysts including Kelvin Dalrymple and Scott Phillips. ‘Sluggish growth and higher funding costs may further weaken Italy’s fiscal position.’ However, a couple of weeks ago S&P reaffirmed its own view of Italy at a level one notch higher at BBB with a stable outlook. Fitch has a similar view.


The end of April saw France downgraded. Fitch reduced France’s credit rating to AA- from AA, with a stable outlook, bringing the euro area’s second-largest economy to the same notch as countries including the Ireland and the Czech Republic. France’s projected budget deficits for this year and next year “are well above” the median for countries with AA ratings, Fitch said in a note. This rating cut spoils President Macron’s credibility as an economic reformer pledging to reduce debt and spur growth, just as he was already struggling to sell his policies to French people including raising the pension age. Elsewhere France is rated Aa2/AA, stable/negative.


As mentioned, we saw good news from major banks when Barclays, Commerzbank and NatWest were all upgraded in the last couple of months. Conversely, U.S. Regional Banks saw further downgrade actions, after the initial wave which followed the collapse of SVB and Signature Bank. Moody’s has been using up its red ink by downgrading Bank of Hawaii, Comerica, First Hawaiian Bank, First Republic Bank, Intrust Bank, MUFG Union Bank, UMB Bank, US Bancorp and Washington Federal Bank, Western Alliance Bank, Zions Bank. There will surely be more downgrades this month.


New issues


Investment grade new issuance for April came in at $65.7bn, well short of a consensus calling for $100bn. It is thought that May, traditionally an above average month for issuance, could see as much as $135bn launched, but could again disappoint. Corporate bond issuance in March nearly ground to a halt after the collapse of regional banks SVB, Silvergate and Signature prompting fears of broader instability in the broader U.S. banking system, while also producing volatility and huge swings in the financial markets. However, borrowers could bolster their balance sheets during the coming weeks as more leave their earnings blackout periods behind. So far, we have seen a better-than-expected earnings season so companies may want to raise capital due to an uncertain business environment in the near future.


Besides the banking sector, the High Yield market also burst into life last month pricing $18.8bn of new bonds. Certainly, the amount of HY issuance is still extremely low but still ahead of last years $53.3bn that was issued to date, compared this year’s total of $57.7bn.


Of note last month was the massive demand for last week’s UK inflation-linked gilt issued by the UK’s debt office. The orderbook reached a record £46bn for the £4.5bn 2045 note, indicating demand for inflation hedge bonds remains extremely high. The massive demand for the bond stems from the UK’s sticky high inflation numbers. We believe that as fixed income investors we believe that the breakeven rates on link-linked bonds remain too expensive for our portfolios.


Philip Morris comes back to the market


In February American tobacco giant Philip Morris (PM) came to the market with a $5.25bn four part 3, 5, 7, and 10-year deal from a book of $11.4bn. Buoyed by the success of the that deal, PM came back to the market to tap these bonds raising a further $2.45bn. This time the A2/A- rated company had orders for $7.6bn.


One of the most successful bond issues last month was for another American tobacco company. Constellation Brands, received orders of $4.9bn for its single $750m 10-year Baa3/BBB bond issue.


Walmart issue success


Walmart Inc. raised $5bn from very robust demand with a $28bn orderbook. The world’s largest retailer launched a 5-part deal with maturities ranging from 3 years to 30 years. These senior Walmart bonds are rated highly at Aa2/AA/AA, all stable. The most successful tranche was the 30-year which garnered $8.5bn itself. Since launch in mid-April all the tranches are trading at tighter spreads.


Banking results season


American Express, Bank of America, Bank of New York Mellon, Canada Imperial Bank, Morgan Stanley, Royal Bank of Canada and Wells Fargo all returned to the high-grade corporate dollar bond market last month. These were the first large U.S. lenders to sell bonds since the collapse of Silicon Valley Bank and two other American banks. Citigroup, Goldman Sachs and JPMorgan remain candidates to launch new debt this month. Corporate borrowers have taken longer to return to the market.



Trevor Cooper FCISI

Chief Executive Officer

Chief Investment Officer

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