Trevor Cooper FCISI
Naisbitt King Bond Market Commentary 3rd September 2021
Fed rates timetable
Chinese bond market tested
Greenwashing comes to bite fund manager
Since our last Bond Commentary at the beginning of August, the twin challenges of inflation and Covid19 are still very much with us. Central banks are still wrestling the problems of policy and rate changes. At the Jackson Hole symposium last week, Federal Reserve Chairman Jerome Powell delivered his opening remarks suggesting that a formal taper announcement will occur sometime this year but left the exact date unclear. It is also unlikely the Fed will raise rates until after the taper is finished possibly in July or August next year at the earliest. The Fed has the twin mandates of stable pricing – a sustainable inflation target of slightly above 2% - and maximum employment. Both of which could be seen soon. However, we do not see the first rate hikes occurring until early 2023. Short end futures are currently pricing in a 25bps rate rise.
China is thought to about to bring in a still wider crackdown on tech companies going public overseas. According to the United States-China Economic and Security ReviewCommission, an American governmental agency, approximately 248 Chinese companies, worth a combined $2.1trn, were listed on US exchanges as of May this year. While that does not seem much in comparison with the approximate $46trn capitalisation of the entire US market, the potential impact could still be huge. Despite these problems we saw a new Chinese tech dollar bond issue come to the market a few weeks ago, which was watched with great interest. Baidu Inc., a Chinese internet search engine company, was able to successfully test the market by selling $1bn of 5.5-year and 10-year dollar bonds in a two-part sustainable deal, marking the first major global debt offering by a Chinese tech company since Beijing escalated a crackdown on private enterprise. Investors seemed not to be put off by the Chinese government interference as good size orderbooks were created for both bonds. The $300m 5.5-year achieved a cover of 8.3 times with a book of $2.5bn and the $700m 10-year received orders for $2.75bn. Baidu is rated A3/A both stable. Since launch both bonds have performed in line. In April I wrote about the troubles of Chinese distressed-debt manager China HuarongAsset Manager. Its bonds had fallen 40% in a month as rumours that the government would refuse to bail-out the company. In August, after months of speculation over the firm’s future a rescue package was unveiled which included a capital top up. This gave rise to a surge in the company’s dollar bonds. The company’s released its long delayed its 2020 results at the end of August which revealed a record loss of $15.9bn, high leverage and capital buffers way below that is required by regulators. The company also announced that government backed investors would recapitalise the firm. China Huarong also said that there are no plans to restructure debt and that preparations have been made to meet future bond payments, helping send its dollar bonds surging, as can be seen in the chart below.
Chart show the extreme price volatility of the China Huarong 3.375% 2030 dollar bond
Moving in the opposite direction is the China Evergrande Group. The digital technology company that owns real estate development, health and other industries has been under pressure for many years but since June it has been more extreme. This weekEvergrande’s dollar bonds accelerated their declines following a warning from the company that it risks defaulting on its borrowings. The Shenzhen based company said in its earning statement this week ‘The group has risks of defaults on borrowings and cases of litigation outside of its normal course of business,’. Overall, its liabilities rose to an amazing 1.97trn yuan ($305bn). Evergrande will need to increase asset sales and to continue to aggressively discount apartment prices to generate sufficient cash to meet its obligations. Highlighting the fact that bond investors have little faith in the company is demonstrated by the $4.68bn secured note. Evergrande announced it will repay the bond early in October at 104.38, but it is trading at a price of just 25.00 – so not much faith there then! Naisbitt King has never had China Evergrande bonds in any portfolios. We are also now in the process of reducing our, admittedly small, exposure to China.
In our Bond Commentary in June, I wrote of the problem of companies ‘greenwashing’ - the disinformation by a company to present an environmentally responsible public image. This week Deutsche Bank’s asset-management arm DWS Groups’ shares fell after it was announced that U.S. and German authorities had started an investigation into the sustainability claims of its funds. The allegations are that DWS overstated its sustainability credentials on some of its investments. Although DWS doesn’t have any issued debt its equity has fallen 13% this week. This is a real setback for DWS as the green, sustainable, area of investment has been a key strategy. A whistle blower, its own Group Sustainability Officer, was dismissed earlier this year, after only working for six months, when she claimed the company’s actions on green products fell short of its words. This development with its subsidiary has not affected Deutsche Bank shares nor its bonds, however. A study conducted as part of the EDHEC-Scientific Beta 'Advanced ESG and Climate Investing' research chair shows that the reality of traditional climate investing strategies does not live up to the promises and the communication from their promoters.As I said in June, Naisbitt King Asset Management is ‘wary of Greenwashing’ and those making false claims.
At the end of this year the London Interbank Offered Rate (LIBOR) will cease to be used as a reference index. The LIBOR is an interest-rate average, introduced in the 1970’s, calculated from estimates submitted by the leading banks in London. LIBOR is calculated in five currencies and seven borrowing periods from overnight to one year. In June 2012, multiple criminal settlements by Barclays Bank revealed significant fraud and collusion by member banks connected to the rate submissions, leading to the LIBOR scandal. Due to multiple factors, including the LIBOR scandal, concerns about the rates' accuracy, and changes in how banks do business, the decision was made to phase out LIBOR. Most LIBOR settings will stop being issued, or will become unrepresentative at the end of 2021, while certain U.S. dollar settings will continue to be provided until the end of June 2023. Most instruments using LIBORwill transition to their various alternatives, but the Financial Conduct Authority may continue to publish synthetic rates after the announced end dates for loans that cannot easily transitioned. Replacements for LIBOR include Secured Overnight Financing (SOFR), Tokyo OvernightAverage Rate (TONAR) and Sterling Over Night Index Average (SONIA). Those credit securities that had their call fixes described against LIBOR in their original prospectuses have now had the terms altered to new formulas. Besides using the LIBORreplacements described above, they may also use swap rates and yield curve rates, amongst other rate alternative vehicles. In preparation for is termination, bonds that have been issued in the last couple of years or so have prospectuses that describe their alternative calculation methods. In January 2020Citigroup launched a dollar bond with a call feature tied to LIBOR, however it did have a covenant looking to the future. At the time of the issue, the new replacement index ‘SOFR’ was determined as its replacement. In the bond’s prospectus was the following description of its transition:
Under the benchmark transition provisions, if a Benchmark Transition Event and its related Benchmark Replacement Date occur with respect to LIBOR, then the rate of interest on LIBOR-linked floating rate debt securities will be determined using SOFR (unless a Benchmark Transition Event and its related Benchmark Replacement Date also occur with respect to the Benchmark Replacements that are linked to SOFR, in which case the rate of interest will be based on the next-available Benchmark Replacement). In the following discussion of SOFR, when we refer to SOFR-linked debt securities, we mean floating rate debt securities at any time when the rate of interest on those debt securities is or will be determined based on SOFR.
French reinsurer SCOR SE produced strong 1st half results, ahead of consensus, at the end of July. SCOR made an operating profit of €100m compared to a loss of €111m in the same period last year. Net income for the half year came in at €380m against just €26m in last year first half. It also reinstated its dividend. Since releasing the results the companies shares have gained 12%. The SCOR bond we bought recently is one that we already hold in various portfolios. The bond was issued in 2018 and is the company’s only dollar denominated debt. It is a $749m junior subordinated bond with a 5.25% coupon and a call in March 2029. This well rated bond still yields over 4% to its call. SCOR, at senior unsecured level, is rated Aa3/AA-/AA-, all stable outlook, with the junior bond described rated Baa1/A-. Ashtead Group is an international equipment rental company trading in the U.S., UK and Canada. Founded in 1947 in Ashtead, Surrey and is quoted on the London StockExchange, but now 85% of its revenue is generated in America through its subsidiary Sunbelt Rentals. Since the beginning of last year, the shares have seen a 136% increase - 123% year-to-date. The company has maintained its dividend payments. At the beginning of August, in a bid to cut its borrowing cost, Ashtead launched 2 new bonds, whose proceeds went to 2 existing 5 and 6-year bonds that had a nominal value of $1.2bn. The new 6 and 10-year senior bonds raised a total of $1.3bn. Ashtead is rated Baa3/BBB-/BBB- all stable. We believe the low leverage and the first bond maturity not due for five years, will continue to support its bond spreads. As reflected in the share price the pandemic does not seem to have adversely effected the company’s business. One of our key ratios we look at is Net Debt/EBITDA. At last count in April this was 1.87, down from 2.42 the year before (anything less than 3 is considered acceptable). We decided to purchase the $750k 10-year bond that has a coupon of 2.45% and was launched on a spread of +130bps. At launch investors put up $3.6bn, 4.8 times for this bond. Although brought on a tighter spread of +120bps the yield was 2.50%. We have held Ashtead bonds for some time now and added this new issue to some portfolios this week.