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  • Writer's pictureTrevor Cooper FCISI

Naisbitt King Bond Market Commentary September 2023

Updated: Oct 25, 2023

  • Brighter outlook for fixed income markets

  • New issues

  • One Oak, Inc five-part new issue to help fund Madellan merger

  • More hope for the CoCo market as investors rush to buy the new BNP bond

  • Preferred share issuance

  • Regional bank downgrades

  • Italian government places a windfall tax on its banks

September 2023

We seem to be changing from higher for longer outlook to a high for longer one: With the market coming to a realisation that interest rates are going to stay high for longer the Fed seems less likely to raise its rate too much further but will have it current rates in place for some time. Treasury yields took a turn for the worse during August with the 10-year reaching 4.34%, a level not seen since 2007. With a still inverted curve the 2-year yield crossed the 5% level for the second time this year, which itself was a 15 year high. Since hitting that 15 year high, the 10 year has fallen back to 4.27%. Treasuries have been a key driver of the global debt selloff as resilience of the world’s largest economy defies expectations that a run of Fed interest-rate hikes would spark a recession. Despite possible evidence of slowing inflation rate, Fed Chair Jerome Powell said at the Jackson Hole conference on 25th August that the U.S. central bank is prepared to raise interest rates further if needed and intends to keep borrowing costs high until inflation is truly on a convincing path toward the Fed’s 2% target. “Although inflation has moved down from its peak — a welcome development — it remains too high,” Jerome Powell also said “We are prepared to raise rates further if appropriate, and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.”

UK gilts also saw a surge in yields to a multi-year high in August. Inflation was seen to refuse to weaken and strong wage data boosted investor bets that the Bank of England will need to raise interest rates further, perhaps with a couple of further rises to 5.75%, then possibly keeping them at that high level for some time.

Brighter outlook for fixed income markets

We believe that there is now a brighter outlook for bonds with rates appearing to approach their peak and credit spreads looking to be normalising. We think that there is now a convincing argument for investing in the fixed income market given the current yields available and, in many cases, the opportunity for respectable capital appreciation. We consider there are bonds available with the appropriate risk / reward and, given our research, very much investable. We believe in allocating investment grade corporate bonds, which offer a longer duration and a yield approaching 6%. We’re also finding attractive portfolio opportunities in other credit categories, including high yield, and will maintain a diversified approach rather than targeting a single specific sector.

New issues

As I have said in the past, 2022 was a bruising year for all markets and the international bond market proved no different. The dollar investment grade primary market saw just $78bn reach the market in September last year but investment-grade bond sellers are now poised to bring to the market significant new debt offerings. Banks that underwrite the bonds now expect about $120bn to be issued this September however this is still down on the four-year monthly average of $136bn. The expected sales come after another rise in U.S. interest rates last month made it more expensive for companies to issue debt. Issuers will likely try to get deals done prior to the Federal Reserve meeting on 20th September. In the past two years, the first days of September have been among the busiest of the year with borrowers selling $77bn and $51bn in the four days following Labor Day in 2021 and 2022, respectively.

One Oak, Inc five-part new issue to help fund Madellan merger

American diversified energy company Oneok, Inc launched a 5-part deal raising $5.25bn. Maturities ranged from 3 to 30-years and coupons from 5.65% to 6.05% for the longest date. The senior debt is rated Baa2/BBB/BBB all stable. Since launch the tranches have been successful with all tightened their spreads.

Proceeds from the deal will be used for the cash consideration portion of the $18.8bn cash and stock merger for Magellan Midstream Partners. The deal will give ONEOK, until now a transporter of natural gas liquids and natural gas, access to Magellan's refined products and crude oil transportation business. The success of the merger isn’t straightforward as Magellan’s largest holders, including Energy Income Partners, the company's fourth largest unitholder with a 3% stake, is arguing that the premium in the deal doesn't justify the tax bill that unitholders will have to pay. The new bonds have a ‘Special Mandatory Redemption’ feature whereby the bonds will be repaid at 101.00 if the merger does not proceed.

More hope for the CoCo market as investors rush to buy the new BNP bond

In another boost to the AT1 Contingent Convertible (CoCo) market we saw BNPParibas launch a very successful junior subordinated bond at the start of August. Investors rushed to place orders for the new bond which enabled the bank to tighten the issue spread by 50bps, meaning a 8.50% coupon was possible. Final orderbook came in at a very healthy $7.7bn for the $1.5bn bond. The first call is in August 2028, when if not redeemed, the coupon calculation would come in at just under 8.50%. Since it’s launch, the bond has tightened its spread by at least 25bps.

The end of August even saw UBS exploring the launch of its first tier 1 bond since its takeover of Credit Suisse after it upset holders of its own AT1 bonds, costing investors $17bn in default.

At the end of August Intesa Sanpaolo Spa was able to issue an AT1 CoCo bond. The bank was able to build a large orderbook for the euro denominated deal. As with other recent deals the strength of demand allowed the bank to lower the coupon from an original 9.625% to 9.125% after €5bn was put up for the €1.25bn bond. The Ba3/BB-/BB- junior bond has a first call in September 2029.

Preferred share issuance

The market for new preferred shares in the U.S. is also reopening after a near half-year freeze, raising hopes that this crucial source of capital — especially for America’s major banks — is returning to normal. Like the Additional Tier 1 market, the new issues mark the return of sizable deals in the primary market for these preferred shares, after Silicon Valley Bank and Credit Suisse’s demise sent adverse signals through the market for all subordinated securities globally. After five months without any noticeable issuance, some household names are once again seeing an opportunity to sell new preferred shares. Goldman Sachs and Wells Fargo have both launched new, very well received, junior debt. Investors are finding preferreds’ attractive as they offer high yields in compensation for the subordinated nature to all types of debt and a variable repayment timetable.

What are Preferred shares? They are like bonds in that they are issued at a par value with a coupon. They can be redeemed later when they reach maturity, and they pay regular dividends. However, they are riskier investments than bonds because bondholders will be paid first in the event of a company failing. Since they don’t confer voting rights, they are not of interest to shareholder activists. They are attractive to risk-averse professional investors, looking for regular passive income.

Regional bank downgrades

Moody’s lowered the credit ratings on 10 small and midsize U.S. banks as part of a sweeping look at the mounting pressures on the industry. Higher funding costs, potential regulatory capital weaknesses and rising risks tied to commercial real estate loans amid weakening demand for office space are among strains prompting the review. “Collectively, these three developments have lowered the credit profile of a number of US banks, though not all banks equally,” Moody’s wrote. Banks that had their ratings cut included M&T Bank Corp., Webster Financial Corp., BOK Financial Corp., Old National Bancorp, Pinnacle Financial Partners Inc., and Fulton Financial Corp. Moody’s also put a negative watch on other banks including U.S. Bancorp, Bank of New York Mellon, State Street, and Truist Financial.

Italian government places a windfall tax on its banks

Sparking caution on the sector, Italy placed a surprise windfall tax on its banks, which could raise €2bn for the country. The move came shortly after Italian banks unveiled a bumper set of earnings with Intesa and Unicredit raising their full-year guidance for the second consecutive quarter on the back of the ECB’s rapid policy tightening. Net interest income at UniCredit, for example, surged 42% in the first half. Deputy Prime Minister Matteo Salvini announced a 40% levy on the extra profits of lenders, as part of a wide-ranging decree approved at a cabinet meeting. Analysts at Citigroup estimated it would wipe 19% from earnings. Within days of the announcement the Italian government backtracked on part of its new windfall tax, saying it would introduce a cap to limit the impact for many lenders as it tries to calm a retreat that wiped out $10bn from the Italian banks’ market value. The levy won’t exceed 0.1% of a firm’s assets and banks that have already increased the interest rates offered to depositors “will not have a significant impact as a consequence of the rule,” the finance ministry said. Initially, Italian bank shares and bonds fell sharply but have since recovered somewhat.


Trevor Cooper FCISI

CIO Naisbitt King Asset Management

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