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  • Writer's pictureTrevor Cooper FCISI

Naisbitt King Bond Market Commentary 6th August 2021

Taking a summer break, our next Naisbitt King Bond Market Commentary will be 3rd September

  • Our strategy

  • International bank results impress

  • Tech companies continue to boom

  • Mixed outcomes for new bond launches

  • PEMEX downgrade leaves bonds unchanged

  • Deutsche Bank continues recovery with Moody’s upgrade

  • Recent trade success

It should be remembered that nearly all articles that discuss the performance or perils of bond markets are describing sovereign bonds, mostly U.S. Treasuries and gilts, not credit. This limits the yield and puts a political and economic edge to their arguments. For us, the strategy of holding a high weighting of corporate and financial fixed interest holdings, with few sovereign bonds in our portfolios, leads to higher yields with less volatility. We believe that in a rising interest rate environment that we may find ourselves in, in the coming years, this strategy gives our clients safe income with capital protection. In exploring and researching bonds to purchase it is worth noting that we are far from being bottom-fishers to gain more yield at the cost of high risk. We do not purchase ‘distressed debt’ and do not look for high risk, low based recovery situations. We fish in the productive pelagic, middle region, of the ocean. We look for bonds in companies that have underperformed to their peer group or have drifted to an oversold position. We also keenly monitor the new issue market as this reflects the health of the market and can be a good source of profit for portfolios. We are also comforted by the low default rates that, currently, have no sign of increase. These strategies have proved successful in the last eighteen months - the most volatile period most investors would have ever encountered.

Yesterday the Bank of England left rates unchanged and signalled that it does indeed have concerns about inflation over the next three years. Once again, the bank said it was in no rush to act, which probably means the first interest rises could occur in the second half of next year. Others still do not expect the benchmark rate, currently at 0.1%, to reach the initial trigger point of 0.5% until the second half of 2023. The scale of the UK’s borrowing has left the public finances six times more sensitive to interest-rate changes than before the financial crisis, according to the Office for Budget Responsibility.

Bank results

Bumper bank results with the largest 12 firms producing a total profit of an incredible $170bn in the past year. JPM Chase was earning the equivalent of $131m a day! We have been saying for a long time that investments in the junior debt of systemically important international banks gives good safe income and returns for bond investors.

Tech companies boom

The big five tech companies also reported bumper profits last week. Alphabet, Amazon, Apple, Facebook and Microsoft produced record quarterly profits. The Coronavirus has certainly been a bonus for big tech it seems. The problem for fixed income investors like ourselves is that, although we would like to invest in these companies, the bonds are just too expensive with minimal yields. We will continue to monitor but they almost fall into the sovereign debt category. Despite its record profits Apple held its cap out to investors for more funds last week. The world’s largest company launched a 4-part deal to raise $6.5bn, following the $14bn raised in February. The cash raised will go to funding dividends and buying back shares. In the past bond investors were not keen to ‘pay’ equity holders - sometimes their fund manager colleagues - but these days that does not seem to be the case. Bond investors were not shy putting up as much as $20bn for this $6.5bn deal.

Apple continues to make significant investments to support its long-term growth. It generated $21bn of operating cash flow and returned $29bn to shareholders during the third quarter. Apple is rated Aa1/AA+ both stable. The $1bn 10-year tranche carries a coupon of 1.7% and is currently trading half a point higher.

Mixed fortunes for new issues

American education materials publisher McGraw-Hill Education sold two tranches of high-yield notes last week, both have been underperforming since launch. The company was not faring too well from the start of the launch process and had to downsize the deal from $2.025bn to $1.625bn. Issued in two tranches, one senior secured with a coupon of 5.75% – rated B2/B-, and one senior unsecured with an 8% coupon – rated Caa2/CCC+. Both were downsized, with the secured tranche cut from $1.15bn to $900m and the unsecured from $875m to $725m. The tricky start has continued since launch with both bonds underperforming.

Easier time for Air Canada

Unlike McGraw-Hill, Air Canada’s high yield offering was a huge success. Air Canada’s new bond and loan offering was upsized to $5.7bn from $5.35bn. The airline issued two bonds, one in U.S. dollars and one in Canadian dollars. The USD tranche is a $1.2bn, up from $1bn, 5-year senior secured bond with a 3.875% coupon, down from talk of 4.25%. The other is a C$2bn, up from C$1.5bn, 1st lien 4.625%, with a 2029 maturity. That is the largest ever sub-investment grade bond in the Canadian currency. Ratings of both bonds are Ba2/BB-/BB, negative/negative/stable. Proceeds will fund repayments of existing debt including C$200m 4.75% 2023 and C$840m 9% 2nd lien 2024.

The transaction is Air Canada’s first major debt deal after getting a federal bailout package in April consisting of loans and equity worth nearly C$5.9bn ($4.7bn), making the government a shareholder for the first time since the 1980s. Air Canada’s financing is secured by the airline’s international slots, gates, and routes, with a combined appraised value of about $12bn. This type of collateral has also been used by Air Canada’s rivals such as United Airlines to issue debt in U.S. dollars. Both bonds, especially the CAD, have done well since launch.

Credit Suisse still able to raise cash

Despite the huge losses and rating downgrades at Credit Suisse (CS) the bank was able to easily borrow U.S. dollar cash. The Zurich-headquartered bank launched a 3-part deal, raising a total of $3.75bn, the longest being a 5-year $1.75bn fixed rate note. A 5-year floating rate note was abandoned. Credit Suisse’s exposure to the March collapse of family office company Archegos Capital Management cost it at least $5.5bn and spurred sweeping risk management changes. The bank replaced several executives, cut its dividend, paused share buybacks, and raised capital. CS is currently rated, at senior level, A1/A+/A, stable/negative/negative.

The CS deal follows debt sales from Bank of America, Morgan Stanley and Goldman Sachs among other Wall Streetbanks last month. While investment-grade spreads have widened since then, it remains an attractive time for big banks to borrow.

Moody’s cuts Pemex deeper into sub-investment grade

Petroleos Mexicanos – Pemex - was cut one notch by Moody’s to Ba3 last week. Its outlook remains negative. The company faces high debt maturities while it expands refining capacity and production. The downgrade adds to the challenges facing the embattled company, which has struggled to deal with a ballooning $114bn debt burden and reverse a decades-long decline in production. Mexico’s new government has pledged to return Pemex to its former glory by dismantling the liberalising energy reforms of the previous administration. President Obrador’s administration has cancelled new oil and gas auctions, designed Pemex as the operator of a giant field discovered by foreign companies, and cracked down on private fuel importers to give the state driller the upper hand. Pemex is expected to receive additional financial aid from the government this year. Mexico’s incoming Finance Minister Rogelio Ramirez de la O is going to prioritize refinancing Pemex. Despite Moody’s downgrade the company’s bonds have hardly moved. The 10-year senior unsecured note currently yields around 6.25%, roughly where it has been all year. Not all the rating agencies have the same view however as S&P still rates the company at an investment grade BBB, albeit with a negative outlook. We continue to hold Pemex bonds in some of our portfolios.

Moody’s upgrades Deutsche Bank

In a recent ‘Recent trades’ sector I described our recent purchase of a Deutsche Bank bond. Yesterday Moody’s updated the German bank, at senior level, by one notch to A2, the highest since 2014, still leaving it on positive outlook. Last week, Christian Sewing the bank’s CEO, raised the revenue outlook on the back of another strong quarter in fixed-income, suggesting that the higher business volumes will help the bank meet a key profit target next year, despite some unexpected costs. Sewing’s restructuring plan runs through the end of 2022. The junior subordinated bond we bought has also been upgraded to Ba3. It has risen 2 points in price since our first purchase. With both S&P and Fitch having their rating on positive outlook, we expect to see them posting upgrades in the coming months.

Recent trades

Taking advantage of the flattening Treasuries yield curve we decided to transact a trade to shortener the maturity. At the end of last year, we bought a bond for Saudi Arabian Oil (ARAMCO). The bond we bought at the time was a $2.25bn 3.25% senior unsecured note with a maturity in 2050. Deciding to reduce duration, we picked another, shorter, ARAMCObond to switch into. When we originally bought 2030 ARAMCO bond the Treasury 30 to 10 year curve dropped 76bps, this is down to 65bps today. Taking advantage of this flattening curve we switched the longer ARAMCO bond to the shorter dropping just 0.52% in yield. Incredibly in the short time since the trade, the switch would now drop over 1% in yield. The shorter ARAMCO bond we bought was part of a 3-part $6bn deal issued in June, `which gathered a massive orderbook of $60bn. The $3bn 10-year bond we bought is a senior unsecured SUKUK that has a coupon of 2.694%. This bond was launched at a price of 100.00 in June, bought by us at 98.10, but is currently trading at 103.00. Both these senior unsecured bonds are rated A1/A.

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