Courtesy of Almost Daily Grant's, originally published June 11, 2020.
Mr. Congeniality
Here’s Commander-in-Chief Donald Trump on Twitter this morning:
The Federal Reserve is wrong so often. I see the numbers also, and do MUCH better than they do. We will have a very good Third Quarter, a great Fourth Quarter, and one of our best ever years in 2021. We will also soon have a Vaccine & Therapeutics/Cure. That’s my opinion. WATCH!
Also today, White House economic advisor Larry Kudlow offered his own critique on Fox News:
I do think Mr. Powell could lighten up a little when he has these press offerings. You know, a smile now and then, a little bit of optimism, OK? I'll talk with him, and we'll have some media training at some point.
Double vision
A decimation wasn’t enough. The Financial Times reported Tuesday that the Vision Fund, SoftBank Group Corp’s in-house venture capital operation, will cut some 15% of its workforce. That’s up from reports pegging layoffs at 10% of staff as of late May, and follows the disclosure of a $17.7 billion net loss in the 12 months through March 31. Not everyone at the Vision Fund has reason to feel glum, as CEO Rajeev Misra is set to take home a $15 million pay package this year, more than double the $7 million in compensation for 2019.
As the Vision Fund flounders, SoftBank and its charismatic CEO Masayoshi Son attempt to steer a new course, announcing plans to divest some $42 billion in assets to finance stock buybacks and bolster corporate liquidity. Those planned sales potentially include a portion of its crown-jewel stake in Chinese retail giant Alibaba, Inc. In addition, SoftBank reduced its stake in cash-generating Japanese telecom subsidiary SoftBank Corp. to 61.5% from 66.5%, according to a May 22 filing.
Investors have largely cheered Son’s latest maneuvers, as shares have nearly doubled from their March lows and now sit 18% higher from an initial bearish salvo in the Dec. 15, 2017 edition of Grant’s.
Markets may make opinions, but dissenting voices remain. A report today from S&P Global Ratings cautions: “We have questions on the company's intention to adhere to financial management that prioritizes financial soundness and creditworthiness.”
As do we.
Benches clear
“Brawls Erupt in U.S. Debt Markets After Borrowers Get Desperate,” blares a headline from Bloomberg this morning. The upshot: a raft of disputes have broken out between distressed companies and their increasingly nervous lenders, as a wave of largely p.e.-backed borrowers “are seeking to take advantage of years of weakening creditor protections to help cut obligations and raise cash after the coronavirus outbreak brought businesses to a standstill.”
In particular, issuers including Sinclair Broadcast Group, Inc., SM Energy Co. and Revlon, Inc. have attempted to shunt assets out of their creditors’ reach or impose principal haircuts through debt exchanges, leading to contentious or outright hostile negotiations with their scorned lenders. “Anyone professing to be shocked by it probably hasn’t been around very long,” observed Philip Brendel, senior credit analyst at Bloomberg Intelligence.
Indeed, as leveraged loans proliferated during this cycle (growing at a 10.2% compound annual rate from 2010 to 2019, compared to 3.7% for junk bonds), the share of those loans designated as covenant-light (meaning few or no legal protections if the borrower runs into trouble) exceeded 80% at the end of April according to LCD. That’s up from 17% in 2007.
“Rates were suppressed long after they should have been; it drove yield hunger and a non-bank explosion that created misalignments,” Daniel Zwirn, chief investment officer at Arena Investors, commented to Bloomberg. “Now they’re learning once again, there are consequences. We are at just the beginning of this thing. They’re going to fight like dogs to avoid those consequences.”
The roster of potential battlefields continues to grow. Last Thursday, S&P Global reported that the downgrade-to-upgrade ratio for leveraged loans reached 43 to 1 on a trailing three-month basis, up from 3.8 times in February and 8.7 to 1 at the peak of the 2007 to 2009 financial crisis.
Those downgrades have resulted in an increasingly bottom-heavy ratings profile, as roughly 11% of the domestic leveraged loan market is now rated triple-C and below, up from just 2.7% five years ago and approaching the 2009 peak of 11.5%. There’s plenty more where that came from, as analysts at UBS believe that even in the most optimistic scenario (including a return to near-normal levels of economic activity by the end of June) those triple-C-rated ranks will swell to 33% of the market.
Needless to say, the combination of rising corporate distress and proliferation of forgiving legal structures suggests that creditors may find more trouble than they bargained for during this default cycle. A May 20 analysis from Moody’s Investors Service forecasts that recoveries on first-lien term loans will fall to 58% for p.e.-sponsored companies and 62% for non-p.e.-backed ones, far below the realized historical recovery averages of 75% and 78%, respectively.
For an early look at what some unhappy creditors are now contending with, see the analysis headlined “Tomorrow’s debt hearings” in the July 13, 2018 edition of Grant’s.
QE progress report
A further easing off the throttle, as Reserve Bank credit (the sum total of interest-bearing assets at the Fed) rose to $7.113 trillion, up a relatively modest $12 billion from last week’s reading. That compares to a $41 billion sequential increase last week and $138 billion uptick for the week ended May 27 but was enough to push the three-month annualized growth rate to 726%.
Recap June 11
A painful reckoning for stock market Johnny-come-latelies, as the S&P 500 absorbed a near-6% decline led by the energy, financials and materials sectors, to leave the broad index at its lowest close since May 26. The Treasury curve flattened aggressively, with the two-year yield rising 3 basis points to 0.2% while the 30-year long bond fell 11 basis points to 1.4%. WTI crude was clubbed by nearly 10% to below $36 a barrel, gold edged lower to $1,729 an ounce, and the VIX rose to near 41, up a cool 48% on the day.
– Philip Grant
.png)
