Trevor Cooper FCISI
Naisbitt King Bond Market Commentary 12th November 2021
Bank of England surprises the market
Breakeven rates reach 15 year high
No slow up in bond launches
Investors rush to buy new Teva Pharmaceutical green bonds
Emerging Market bond issuance
General Electric Company does the splits – Johnson & Johnson follows
Metro Bank shares and bonds leap on bid from Carlyle Group
Westpac Bank’s return to the international bond markets
Against much speculation that the Bank of England (BOE) MPC meeting last week would raise its rate from the 0.1% level, that has been in place since March last year, the bank chose to keep it unchanged by a 7-2 majority. The BOE indicated concerns over growth and said it was prepared to wait for more information on the labour market before acting. Still, policy makers did increase their inflation forecasts to show a peak of around 5% in April next year, and said a hike would be needed in coming months if the economy evolves as forecast. The committee voted 6-3 to maintain the bank’s gilt purchase target at £875bn and unanimously to maintain its corporate bond target at a monthly $20bn total. The immediate effect was that the yield on gilts fell with the 10-year dropping to 0.93% from the morning’s 1.06%, and the pound dropping 0.82% against the dollar. Since then, gilt yields have continued to drop with the 10-year hitting a low of 1.46% before rising to its current 0.93%. Traders are no longer fully pricing in the BOE’s rate to 1% next year believing that it might be only reached in early 2023 – a bit of a difference from ideas of 1% by August next year. The MPC’s next meeting is 16th December.
Seemingly taking a cue from the Bank of England, the U.S. Treasury bond yields also dropped with the 10-year falling to 1.57% from its start that day at 1.60%. The Treasury curve went back to its flattening course with the difference between the 5 to 30-year Treasury yields dropping to 66bps, a level last not seen since the start of the pandemic in March last year.
Breakeven rates rise again
Once again, we have seen breakeven rates rise, this time to a 15 year high. The rate for the 10-year has now reached 2.70%, meaning investors expect inflation to average 2.7% over the next 10 years. If we believe that inflation will average less than 2.7% in the coming decade, a fixed-rate bond rather than an inflation-linked bond might be the better choice for our portfolios. As I have explained in previous Bond Commentaries the breakeven rate is the difference in yield between inflation protected bonds i.e. index-linked (TIPS), and fixed debt of the same maturity. The breakeven inflation rate is a predictive measurement that helps us gauge how certain investments are likely to perform during periods of high inflation. We are considering the implications of this rise in the breakeven rate and will act accordingly in due course.
New corporate bond issuance continues high levels
Investor demand for new issues is once again showing little sign of diminishing, The U.S. high yield market is on track to have the busiest year ever as more than $430bn has priced year-to-date, about $1.5bn away from the record set in the whole of last year. Investors have increased their allocation to speculative grade bonds.
Problems remain in the Chinese real-estate market
The worst losses were once again seen in the Chinese real-estate sector. Bonds of Yango Group, Kaisa Group and Modern Land China dropped more than 70 cents on the dollar amid a crackdown on excessive leverage and a liquidity crisis at property giant China Evergrande. Chinese property companies with strong balance sheets are trying to restore investor confidence after yields on their bonds surged to more than 20%, the highest in at least a decade. Credit rating firms are downgrading real estate companies at the fastest pace on record, and at least four property developers defaulted last month as contagion from the crisis at China Evergrande spreads. Showing a small recovery, bonds for Country Garden have improved. A fortnight ago its debt had fallen below a price of 75.00, however it has now recovered to 90.00, still below the 100.00 trading level in September.
Emerging Market bond issuance
Emerging-market debt losses were not limited to China. Among sovereign issuers, Brazil’s September 2031 securities and Turkey’s September 2033 bonds fell after their launch. Developing-nation issuers have raised around $653bn this year, similar to last year, but issuance fell 15% in October from a year ago, suggesting sales are slowing. In fact the price of two-thirds of Emerging-Market (EM) bonds sold this year fell after launch, erasing about $9bn from the portfolios holding them. Of the 563 EM dollar-denominated corporate and government bonds sold this year, 371 fell in price with an average loss of 2.8%, according to data compiled by Bloomberg. The expected withdrawal of liquidity by the Federal Reserve and the European Central Bank could force issuers to offer concessions to lure buyers, or else postpone borrowing. Borrowers, including Sri Lanka and El Salvador, could now find the market closed to them and countries such as Turkey will find it very expensive and may struggle due to sovereign volatility. Naisbitt King Asset Management has little exposure to EM bonds.
Investors rush to buy new Teva green bonds
Last week Teva Pharmaceuticals, one of the largest generic-drugmakers in the world,saw its shares surge after a judge in California issued a tentative ruling in favour of the company, along with Johnson & Johnson and others in a $50bn opioid case. The lawsuit, brought by local governments in California, accused four drugmakers - Teva, J&J, Endo International and Abbvie's Allergan - of causing or contributing to the opioid crisis through misleading marketing, which increased prescriptions prices. They argued that the companies should pay more than $50bn toward efforts to tackle the epidemic. Orange County Superior Court Judge Peter Wilson rejected those claims and found the drugmakers weren't legally liable in a tentative ruling issued on Monday last week.
This news encouraged Teva Pharmaceuticals, to launch a 4-part euro and dollar sustainability-linked bond (SLB) green deal tied to environmental issues. It was the largest ever SLB tied to climate and access to medicine. Teva Pharmaceuticals raised a total of around $5bn, up from $4bn first requested, from a solid orderbook of $14bn. In euros Teva launched a €1.1bn 3.75% 2027 and €1.5bn 4.375% 2030 and in dollars a $1bn 4.75% 2027 and $1bn 5.125% 2029. With sub-investment grade ratings of Ba2/BB-/BB- negative/stable/negative.
The Israeli company said the bond is the biggest of its kind from any sector and first issued by a generics company. The bond will be tied to a 25% reduction in Scope 1 and 2 greenhouse gas emissions and a 150% increase in access to essential medicines for patients in low- and middle-income countries by the end of 2025. TevaPharmaceuticals said it is also the only drug company to issue a bond with both social and environmental targets. The company recently said it is targeting reducing Scope 3 GHG emissions by 25% by 2030. It will disclose its performance against each target in its annual ESG Progress report. After the issue of their new bonds Teva announced a tender for some of its bonds. Originally tendering for $3.5bn worth of bonds, the company upped this to $4bn.
GE splits itself into three
On Tuesday this week the General Electric Company (GE) announced plans to form three public companies focused on growth sectors of aviation, healthcare and energy. GE Aviation, GE Healthcare, and the combined GE Renewable Energy, GE Power, and GE Digital businesses are to become industry-leading, global, investment-grade public companies. GE intends to execute tax-free spin-offs of health care in early 2023 and of the renewable energy and power company in early 2024. The company will use proceeds from the recently closed GE Capital Aviation Services sale, which raised $31bn, to significantly reduce debt remains committed to continued debt reduction along with strategic capital deployment. This move ends years of speculation about the future of GE, which has been long regarded as one of the most admired U.S. companies but one that’s struggled since the global financial crisis more than a decade ago. Since then, it’s been retrenching from its once extensive conglomerate structure, including the sale of the bulk of the GE Capital finance arm.
We believe this is good news for bondholders as the company is on target to reduce its debt level by more than $75bn over the next 3 years. Until 2009 GE was rated at AAA but in the intervening years since, its ratings have consistently dropped to the current Baa1/BBB level. Investors seem to like this announcement pushing the GE share price higher to 23% this year.
The day after GE revealed plans to split the company it announced plans to buy-back $23bn worth of bonds to cut its debt mountain. It seems that around 70% of the tender offer will be at the intermediate to long end to provide a credible plan to improve cash flow. Since Larry Culp took the helm in 2018, GE has been slashing its debt. The company reported $65.8bn of debt at the end of September, down from %134.6bn at the end of 2017. S&P, in a first move, moved its BBB+ to negative watch. Elsewhere, Moodys have Baa1 and Fitch BBB ratings on GE, with negative/stable, on GE’s senior unsecured debt.
Johnson & Johnson to break in two
Today, Johnson & Johnson (J&J) also announced a split, this time into two. The company said it will break itself up into two public companies, one focused on drugs and medical devices, and the other on consumer products. J&J is one of the very few true Aaa/AAA companies, albeit negative outlook. Moody’s believes that the separation reflects a reduction in scale, diversity and earnings. There is currently no change to J&J's Aaa long-term rating, but Moody's say they will continue to evaluate the credit implications of the separation as more details become available and as the transaction date gets closer. The split could take 18 to 24 months to complete. The transaction is subject to various internal steps as well as final approval by the J&J's board and other conditions including receipt of a favourable tax ruling and various regulatory approvals. The market’s immediate reaction was mark up the company’s shares but mark down its bonds. Naisbitt King Asset Management has never held Johnson & Johnson debt as we have always thought it too expensive.
Metro Bank shares and bonds leap on bid from Carlyle Group
Metro Bank was founded in 2010 as the first new high street ‘challenger’ bank to launch in the UK in over 100 years. This valued the bank at £1.6bn. After a period of fast growth, 2019 saw the bank announcing that it had insufficient capital to meet its regulatory requirements. This sent its shares spiralling down from it high of £40 to just £2. At the beginning of last week, the share price had fallen further to around £1. In June 2018 Metro Bank launched a £250m 10-year subordinated bond, with a coupon of 5.5%. By October 2019 the bank had to pay 9.5% for a 6-year £350m bond. Last week Metro confirmed an approach by U.S. private equity giant Carlyle Group. Both its share and bond prices soared on the news. The share price leapt up 28% to value the bank at £222m, and its 2028 subordinated bond, that has a call in June 2023, jumped from a price of 63.50 straight to 75.50 – a yield of 25%. Naisbitt King Asset Management has never had any Metro Bank bonds in any portfolios. Carlyle Group has until 2nd December to make a formal offer.
Earlier this week Westpac Banking Corporation launched a U.S. dollar jumbo deal raising $5.5bn, a record for the Aussie bank. The bank launched a 3-year floating note and 3, 7, 15 and 20-year fixed notes. While the shorter tranches are at senior unsecured level the 2 longer parts are subordinated. All orderbooks were satisfactorily full, with 2.2 times cover for the senior bonds and 3.5 times for the subordinated notes as investors chase yield. The deal marked Westpac's return to more normal levels of wholesale funding, after more than a year of relying on the Royal Bank of Australia’s Term Funding Facility. Westpac is well rated, at senior level it’s Aa3/AA-/A+ and at the subordinated level of the longer bonds Baa1/BBB+/A-, all stable. All the new bonds have done well and are trading at tighter spreads since their launch.