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U.S. BLUES

Courtesy of Almost Daily Grant's 

U.S. BLUES

A little less help for Uncle Sam. While the Fed has scaled back its Treasury purchases to $80 billion per month from a March peak of $75 billion per day, ballooning fiscal deficits ensure that plenty of new government bond supply will need to find a home.   

With projected net issuance of more than $4.7 trillion this year (nearly quadruple that of 2019), analysts at J.P. Morgan calculate that, at the current pace, Fed purchases will account for only 25% of long-term Treasury supply in the back half of the year.

In other words, plenty of “safe” assets to go around. 

PLEDGE PIN

Caixin reports today that 83 tons of gold bars used as loan collateral by Nasdaq-listed Wuhan Kingold Jewelry, Inc. (ticker: KGJI) “turned out to be nothing but gilded copper.”  That’s bad news for upwards of a dozen Chinese financial institutions, which issued more than RMB 20 billion ($2.8 billion) in loans backed by the fool’s gold to the company over the last five years. 

Asked by Caixin if the pledged gold was fake, Kingold chairman Jia Zhihong replied: “How could it be fake if insurance companies agreed to cover it?” 

Disbelief is understandable, considering the size of the potential fraud. That 83 ton cache would be equivalent to 22% of the Middle Kingdom’s annual output and nearly 5% of its gold reserve as of last year. 

DEAL DOOZY

What’s old is new again. Last Thursday, U.K.-based insurance retailer The Ardonagh Group Ltd. issued a £1.58 billion ($1.94 billion) unitranche loan to a consortium of private credit investors led by Ares Management. That’s the largest such loan on record.  

The deal is notable not just for its size. The financing package includes $500 million in 11.5% pay-in-kind toggle notes (which allow issuers to pay the coupon in more debt rather than in cash) due 2027, priced at 99 cents on the dollar for an 11.72% yield.  That’s above initial price talk of 10.5% to 11%. If Ardonagh opts to pay interest in scrip rather than cash, the coupon jumps to 12.75%. 

Lenders may not want to count on much near-term income from the deal. On last week’s conference call, the company indicated it will exercise the PIK option immediately. 

Use of proceeds includes the financing of a pair of acquisitions—acquisitions purchased from funds managed by Ardonagh’s own private-equity investors, HPS Investment Partners and Madison Dearborn Partners. 

Last week, Fitch downgraded Ardonagh’s long-term issuer default rating to single-B-minus from single-B, on account of gross leverage above seven times projected funds from operations over each of the next three years. 

Neither is an improved interest profile part of the corporate calculus, as R.W. Baird director Brian Dirubbio noted last week. According to Dirubbio, the new financing actually increases Ardonagh’s weighted average coupon. 

The transaction rather confers other benefits. By funding the acquisition of businesses that dwelled in the investment portfolios that the p.e. sponsors manage, the bond offering will allow the p.e. pair to “recoup some of the capital they have poured into Ardonagh since 2015 and 2016.” Dirubbio concludes that “the company cannot afford to pay additional cash interest given its current cash flow profile.”

More broadly, the return of the PIK structure signifies the bond market’s forgiving mood, as the prior cycle was unkind to those lenders. According to Moody’s Investors Service, issuers of PIK-toggle debt defaulted at a 30% clip in 2009, compared to a 17% baseline for similarly-rated credits. 

RECAP JUNE 29

Score one for the bulls, as stocks firmly erased overnight weakness to leave the S&P 500 1.5% in the green, narrowing year-to-date losses to 5.5%.  The Treasury curve steepened a bit, with the 2-year yield falling below 16 basis points for the first time since mid-May, while WTI crude rose back near $40 a barrel and gold held at $1,772 an ounce.  A late selloff pushed the VIX below 32. 

- Philip Grant


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