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  • Trevor Cooper FCISI

Naisbitt King Bond Market Commentary 1st June 2022




  • Attractive bond market level

  • Russia nears default

  • Further downgrade for Ukraine

  • Sri Lankan default

  • Thrashing for El Salvadorian dollar debt as it nears default

  • New issuance slow down

  • Moody’s upgrades Irish banks

  • Credit Suisse downgrade


As I peruse the investment landscape, I am both disappointed and optimistic. Disappointed with the dire performance of world markets this year, the S&P 500 equity index is now down over 13% and the tech heavy Nasdaq index down a stonking 22%. U.S. Bloomberg investment grade index - used as one of the major bond market benchmarks – is down 11.5% this year. However, I am optimistic as markets started to recover during May, especially bond markets with the U.S. Bloomberg bond index gaining 2.7% during the month. Whether the turnaround will continue is hard to predict but bond markets had started to look very oversold. First world economies haven’t crashed, and default rates remain low, sure how to deal with Russia is making things difficult, but most commentators seem to think thoughts of inflation and recession will recede next year.


Attractive credit markets


Despite the market recovery, our belief is that bond yields remain at very attractive levels, only briefly beaten in March 2020 when Covid-19 first struck. This year portfolio values have dropped, but of course once purchased, market volatility, geopolitical events, pandemics, supply/demand factors, on any level are completely irrelevant. They do not affect the known cash flow, known income or specific date when an investor’s face value will be returned if an investor holds their bond to maturity. We do not expect to hold bonds until maturity but with prices well below par there will still be a strong pull-to-par.


The U.S. 10-year has had a volatile period over the last month. From a yield of 2.90% at the start it travelled north to 3.20% in the first 9 days but by month end it had dropped back to 2.84%. Looking forward we don’t expect the 10-year to rise much above 3.25% this year.


Russia nears default


The clock is now ticking on a Russian debt default. Russia says it will service its dollar debt in rubles after the expiry of a sanctions loophole closed the option of payments in the US currency, possibly putting Moscow on track to default. In April, Moody’s said an attempt by Russia to pay dollar bonds in rubles would be ‘considered a default’ if the situation isn’t remedied within 30 days of the money being due. Russian sovereign bonds are trading at a price under 20.00 – unchanged from the beginning of March.


Russia is now planning a bond-payment mechanism to get-around U.S. sanctions and a possible default as a grace period ticks down on its latest missed coupons. The proposal would allow foreign investors to open accounts in Russian banks in both rubles and hard currency. Unlike the previous payment system, investors would be able to access the funds without restriction. The mechanism is still being discussed by the government, after which it will be presented to investors.


Ukraine downgraded - again.


Sadly, Ukraine has stepped nearer a possible default. Both Moody’s and S&P lowered their ratings on the country to Caa3 from the Caa2 and B- to CCC+ respectively, both with negative outlooks. Moody’s said that the downgrade reflected the rising risks to Ukraine's government debt sustainability due to Russia's ongoing invasion, which is expected to result in a debt restructuring, along with losses imposed on private-sector creditors.


Sri Lankan debt enters into default


Sri Lanka has been mired in turmoil amid surging inflation, a plummeting currency, and a shortage of the hard currency it needs to import food and fuel. The government is in talks with the International Monetary Fund (IMF) for a bailout and has previously said it needs between $3bn and $4bn this year to pull itself out of crisis. In May, Sri Lanka fell into a default, the first time in its history, as the country grapples with an economic meltdown. Bond coupon payments worth $78m that were due 18th April plus a 30 day grace period, expired in mid-May. One of the 2 defaulted bonds, a $1.25bn 6.75% 2028 has now fallen to a price of 38.00 as the rating agencies put default levels on the county’s credit. Many of Sri Lankan’s bondholders including Pimco, T.Rowe Price and BlackRock have entered into restructuring talks. Sri Lanka aims to have the IMF program in place by mid-June.


EL Salvador default?


Far from being able to launch a bond denominated in bitcoin, it now seems possible the Republic of El Salvador could default its existing sovereign debt. It’s been reported that the country couldn’t find a single investor for its possible $1bn bitcoin bond. The country doesn’t have a bond maturating until January next year, but coupons are of course payable in the meantime. Last September El Salvador was the first country to make bitcoin legal tender. Bitcoin cryptocurrency has now plummeted over 50% from its all-time $68,000 high, hit in December. Senior El Salvador sovereign senior debt is rated Caa3/B+/CCC, all negative.


Naisbitt King Asset Management has never held Russian, Ukrainian, Sri Lankan nor El Salvadorian debt, nor bitcoin!


New issues


May was looking to be the slowest month for sub-investment grade issuance since December 2018, however by the end of the month high yield issuance took a turn for the better. In fact, high yield bonds saw the last week of the month the best in two years. However, year-to-date high-yield bond sales are the lowest since 2009, a marked difference from 2020 and 2021 which saw record issuance.


The first high yield bond of the month was a great success. It came from Frontier Communications, a company that went bankrupt in 2020. Frontier was able significantly upsize its 1st lien offering to $1.2bn from $800m in the offering process. It was also able to price its bond with a coupon of 8.75%, the tighter end of issuance talk. Since launch this bond has done very well, rising by over 5 points by the end of the month.


Issuance of investment grade bonds also decreased. Until May issuance was running ahead of last year but now it is 2% behind. May saw issuance total $86.45bn, well below estimates of around $135bn at the start of the month, the largest miss in over 3 years. However, the average spread on investment grade bonds tightened 6bps, the largest move in more than 2 months.


Credit Suisse downgrade


May saw Credit Suisse downgraded by both S&P and Fitch, leaving a stable outlook. S&P said ‘A series of risk events have shed light on the firm's risk appetite and culture, as well as on deficiencies in its risk control and compliance frameworks. Credit Suisse made millions by looking after the needs of super-rich Russians. The Swiss lender managed more than $60bn belonging to rich Russians, bringing in over $500m to $600m annually to the bank. This revenue source seems to have now come to an end. S&P also suggested that Credit Suisse’s risk-return is likely to remain below that of more highly rated peers over the medium return. Moody’s moved its Baa1 rating to a negative outlook. Credit Suisse’s senior unsecured debt is now rated Baa1/BBB/BBB+ negative/stable/stable.


Irish banks upgraded


Following its upgrade of Ireland’s debt in early May to A1 from A2, Moody’s then upped its ratings on Allied Irish Bank and Bank of Ireland. The rating agency upgraded both banks to A3 from Baa1, leaving a stable outlook. Standard & Poor’s continues to rate both banks at BBB- but revised its own outlook upwards from negative to stable. The upgrade hasn’t made much of a difference to debt prices on either of these entities.

HCA Healthcare upgraded to investment grade


S&P upgraded American hospital provider HCA Healthcare to investment grade last week moving its senior unsecured debt from BB+ positive to BBB- stable. S&P had rated HCA at sub-investment grade level for the past 20 years. S&P said ‘HCA, like its peers, is experiencing several significant headwinds, including labour difficulties, ongoing patient volume volatility related to the impact of the pandemic, inflation, and reimbursement rates. However, HCA's very significant scale and solid market positioning allow the company to generate consistently high cash flow, leading to significant discretion in determining its leverage.’


Elsewhere HCA’s senior debt is rated at Baa3 and BB+, both stable. This rating upgrade has prompted the price of the company’s bond to rise by 4 points.

Regards


Trevor Cooper FCISI

Chief Executive Officer

Chief Investment Officer

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