(Bloomberg) Fed to Buy Junk Bonds Among Other Support
The Fed said it will invest up to $2.3 trillion in loans to aid small and mid-sized businesses and state and local governments as well as fund the purchases of some types of high-yield bonds, collateralized loan obligations and commercial mortgage-backed securities.
The money comes on top of the massive stimulus that the Fed had already announced and it thrusts the institution into the sort of speculative lending activities it had shunned in the past — underscoring the risks that Chairman Jerome Powell is willing to take to shore up the economy.
“We will continue to use these powers forcefully, pro-actively, and aggressively until we are confident that we are solidly on the road to recovery,’ he said in a speech 90 minutes after the details of the measures were announced.
“Our country’s highest priority must be to address this public health crisis,” Powell said in a statement accompanying details of the new actions. “The Fed’s role is to provide as much relief and stability as we can during this period of constrained economic activity, and our actions today will help ensure that the eventual recovery is as vigorous as possible.”
Investors quickly bid up prices on corporate bonds and stocks after the announcement. High-yield debt was among the biggest gainers, with some of the largest ETFs tracking those bonds surging the most in a decade.
But the nature of the Fed’s actions pass the traditional boundaries of the central bank to purchase lower-rated debt and the credit of municipalities, raising questions about its future role.
“Many of the programs we are undertaking to support the flow of credit rely on emergency lending powers that are available only in very unusual circumstances,” he said in his speech. “I would stress that these are lending powers, not spending powers.”
The Fed has deployed nearly every tool in its toolbox since March to try and help keep lending flowing in the economy — as businesses shuttered to stem the spread of the virus. It’s unleashed programs used in the 2008-2009 financial crisis to improve liquidity in the Treasury and credit markets, and reached into unchartered territory to support American businesses, states and local governments.
In a move that surprised some investors, the central bank will also expand its bond-buying program to include debt that was investment-grade rated as of March 22 but was later downgraded to no lower than BB-, or three levels into high yield. It’ll also buy exchange-traded funds, the preponderance of which will track investment-grade debt along with some that track speculative-grade debt. Together, the programs will support as much as $850 billion in credit.
“The reason the Fed had to expand the pool of credit that they are willing to buy is that so many borrowers are slipping into these lower-rated categories,” said Mark Vitner, senior economist at Wells Fargo Securities. “This is aimed more at fallen angels rather that dastardly devils.”
The Fed also said it will continue to closely monitor conditions in the primary and secondary markets for municipal securities and will evaluate whether additional measures are needed to support the flow of credit and liquidity to state and local governments.
Eligible ETFs: The Facility also may purchase U.S.-listed ETFs whose investment objective is to provide broad exposure to the market for U.S. corporate bonds. The preponderance of ETF holdings will be of ETFs whose primary investment objective is exposure to U.S. investment-grade corporate bonds, and the remainder will be in ETFs whose primary investment objective is exposure to U.S. high-yield corporate bonds.
Eligible Individual Corporate Bonds will have a remaining maturity of 5 years or less. The issuer must have been rated at least BBB-/Baa3 as of March 22, 2020, by two or more major nationally recognized statistical rating organization (“NRSRO”).
Additionally, an issuer that was rated at least BBB-/Baa3 as of March 22, 2020, but was subsequently downgraded, must be rated at least BB-/Ba3 as of the date on which the Facility makes a purchase.
The Facility will cease purchasing eligible corporate bonds and eligible ETFs no later than September 30, 2020, unless the Facility is extended by the Board of Governors of the Federal Reserve System and the Treasury Department. The Reserve Bank will continue to fund the Facility after such date until the Facility’s holdings either mature or are sold.
Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were +$2.9 billion and year to date flows stand at -$16.0 billion. New issuance for the week was $4.3 billion and year to date issuance is at $76.5 billion.
(Bloomberg) High Yield Market Highlights
The robust demand for new issuance, coupled with continued fund inflows, has pushed junk bond spreads to a three-week low.
Junk bonds have posted gains in seven of the last 10 sessions.
Investors have been pouring cash into high-yield retail funds for the last three weeks
Nordstrom increased the size of its debt offering by $100m to $600m after getting orders of more than $4b as junk investors sought higher- quality debt
Nordstrom priced at par to yield 8.75% after talk tightened from 10% area to 9%-9.25%
The retailer is still high grade, but fallen angels are expected to outperform high yield, according to Ashish Shah of Goldman Sachs Asset Management said
This was the second investment-grade borrower to tap high-yield investors to increase liquidity by offering attractive coupon, following Carnival
Elsewhere in primary, propane distributor Ferrellgas sold $575m 1st lien senior secured notes, rated B3/CAA, at par to yield 10%
Tightened talk from 10.5%-11%
Earlier in the week, Wynn raised $600m, up from $350m initially, through the sale of five-year notes and cut the coupon to 7.75% from around 8.5%
Junk bond yields dropped to a three-week low of 8.48% while spreads tightened to +785, also a three-week low
BA spreads narrowed to 535bps while yields dropped to 6.04%
Single B yields fell to 8.42% and spreads fell to 779 bps
CAA yields dropped to 16.82% and spreads tightened to 1,641bps
(Bloomberg) Fertitta’s Record Rate Stokes Surge in Demand for Leveraged Loan
A record high interest rate on Tilman Fertitta’s loan sale seems to be doing to trick. Order books for the $250 million deal are at least double that just a day after it was launched, according to people familiar with the matter.
The loan, which matures in October 2023, is being arranged by Jefferies Financial Group Inc. Based on initial discussions with investors, it’s being offered at a spread of 14 percentage points over the benchmark London interbank offered rate with a floor of 1% and at a discount of about 96 cents on the dollar.
That makes the all-in yield at least 16%, according to calculations by Bloomberg. The spread is the highest ever seen in the U.S. leveraged loan market excluding companies in bankruptcy, according to data compiled by Bloomberg. That all-in yield may fall due to strong demand for the debt, the people said.
The Texas billionaire is looking to raise the loan to keep his casino and restaurant empire afloat through year-end if the Covid-19 virus shutdown persists. The offering is ending a near one-month drought in the market for risky corporate loans, but the company will be saddled with excruciatingly high borrowing costs.
To put those costs into more perspective, Fertitta’s Golden Nugget sold a $200 million loan in January that financed a dividend at just 2.5 percentage points over Libor. That loan, which also matures in 2023, has since dropped and is trading at about 75.5 cents on the dollar, according to data compiled by Bloomberg. That equates to a yield of almost 12%, and a premium of at least four percentage points for the new loan.
Update:
Texas billionaire Tilman Fertitta has cut the interest rate on a $250 million leveraged loan sale to keep his restaurant and casino empire afloat and is considering boosting the size of the deal after being inundated with demand from investors.
Potential lenders have submitted about $1.4 billion of orders for the debt, which pays an all-in yield of at least 14%, according to a person with knowledge of the matter. Fertitta is considering increasing the size of the loan to $300 million and will still contribute $50 million of his own cash into the company, the person said, asking not to be identified because the discussions are private.
The loan is now being offered at a spread of 12 percentage points over the benchmark London interbank offered rate with a floor of 1% and at a discount of about 96 cents on the dollar, according to separate people familiar with the matter.
(Reuters) Global oil output cuts held hostage to standoff
Oil producers in the OPEC+ group, led by Saudi Arabia and Russia, were expected to pressure Mexico on Friday to seal an accord for a collective cut in output of 10 million barrels per day, before asking other nations for a further 5 million bpd of cuts.
The United States has encouraged global cooperation to bolster an oil market that collapsed as the coronavirus pandemic accelerated in March and producers resorted to a price war after failing to agree on how to prop up prices.
Oil prices tumbled on Thursday despite OPEC+ nearing agreement as the lockdowns ordered across the world sucked life out of the global economy, and traders reckoned that even a combined reduction of 15 million bpd would be too little to stabilize the market.
(Bloomberg) Fed to Buy Junk Bonds, CLOs and Lend to States in New Stimulus
The Federal Reserve on Thursday announced another series of sweeping steps to provide as much as $2.3 trillion in additional aid during the coronavirus pandemic, including starting programs to aid small and mid-sized businesses as well as state and local governments.
In an unprecedented move, the Fed also said Thursday it would move to shore up some of the hardest-hit parts of financial markets, pledging to start buying some debt recently downgraded to below investment grade as well as certain collateralized loan obligations and commercial mortgage-backed securities.
“Our country’s highest priority must be to address this public health crisis, providing care for the ill and limiting the further spread of the virus,” Fed Chair Jerome Powell said in a statement. “The Fed’s role is to provide as much relief and stability as we can during this period of constrained economic activity, and our actions today will help ensure that the eventual recovery is as vigorous as possible.”
A Municipal Liquidity Facility will offer as much as $500 billion in lending to states and municipalities, by directly purchasing that amount of short-term notes from states as well as large counties and cities.
The Main Street Lending Program will “ensure credit flows to small and mid-sized businesses with the purchase of up to $600 billion in loans.”
Expanding the size and scope of the Primary and Secondary Market Corporate Credit Facilities and the Term Asset-Backed Securities Loan Facility to support as much as $850 billion in credit.
Its Secondary Market facility may purchase U.S.-listed ETFs. While the preponderance of those holdings will be those primarily focused on U.S. investment-grade corporate bonds, the remainder will be in ETFs whose primary investment objective is exposure to U.S. high-yield corporate bonds.
Starting the Paycheck Protection Program Liquidity Facility, “supplying liquidity to participating financial institutions through term financing backed by PPP loans to small businesses.”
Spreads ripped tighter during the week as risk assets of all stripes performed well on the back of extraordinary support from the Federal Reserve. The Bloomberg Barclays US Corporate Index closed the holiday shortened week at an OAS of 233, a whopping 50 basis points tighter from the previous Friday close and over the course of just four trading days. Through Thursday, the index total return for the year was -1.01% after having been down over -10% at one point just a few weeks ago. The big announcement of the week came on Thursday morning as the Fed provided more details for its previously announced plans as well as additional support for the corporate credit markets. The announcement sent spreads sharply tighter into the long weekend.
The primary market posted another strong week. Over a dozen issuers priced more than $37 billion in new corporate debt over the course of the first three trading sessions this past week. Thursday was essentially a “no-go” as there was an early market close for Easter weekend which made the timing of new issuance prohibitive. Consensus estimates for issuance next week are strong again, with most prognosticators coming in around $40bln.
Investment grade credit saw inflows for the first time in five weeks. According to data compiled by Wells Fargo, inflows for the week of April 2-8 were +1.9bbln which brings the year-to-date total to -$30.5bln. As we have alluded to in previous commentaries, if the market starts to see consistent inflows then that could provide a tailwind for credit spreads.
In the first quarter of 2020, the Bloomberg Barclays US Corporate High Yield Index (“Index”) return was ‐12.68%, and the CAM High Yield Composite gross total return was ‐10.03%. The S&P 500 stock index return was ‐19.60% (including dividends reinvested) for Q1. The 10 year US Treasury rate (“10 year”) generally drifted lower throughout the quarter finishing at 0.67%, down 1.25% from the beginning of the quarter.
The 10 year did make a record low of 0.54% in early March. That is just one of the many records to take place across markets in 2020. During the quarter, the Index option adjusted spread (“OAS”) widened 544 basis points moving from 336 basis points to 880 basis points. During the first quarter, each quality segment of the High Yield Market participated in the spread widening as BB rated securities widened 472 basis points, B rated securities widened 532 basis points, and CCC rated securities, widened 836 basis points. Take a look at the chart below from Bloomberg to see the eye‐popping visual of the enormous spread move in the Index. The chart displays data for the past five years. Notice the previous ramp in the Index OAS spread from 2015. That ramp took seven months before reaching the peak and topped out around 850 basis points. The ramp‐up this time around happened inside of five weeks and topped out at 1100 basis points. “It sure was a long year this past month,” is a saying that seems to capture the feelings of many across Wall Street as the first quarter closed.
The Utility, Technology, and Insurance sectors were the best performers during the quarter, posting returns of ‐5.06%, ‐5.31%, and ‐5.95%, respectively. On the other hand, Energy, Transportation, and REITs were the worst performing sectors, posting returns of ‐38.94%, ‐20.90%, and ‐16.87%, respectively. At the industry level, wireless, supermarkets, pharma, and food/beverage all posted the best returns. The wireless industry (‐1.04%) posted the highest return. The lowest performing industries during the quarter were oil field services, e&p energy, retail REITs, and leisure. The oil field services industry (‐49.18%) posted the lowest return.
During the first quarter, the high yield primary market posted $81.8 billion in issuance. That is the total issuance including a market that was essentially closed for the month of March. Issuance within Financials was the strongest with almost 23% of the total during the quarter. The last few days of March did see the high yield market begin to open up just a bit for issuance. That was a very encouraging sign to see. We expect that when the issuance door opens some more, there will likely be a flood of companies coming to market to fortify their balance sheets.
The Federal Reserve was very busy during the quarter. They pulled out all the stops by not only dropping the Target Rate to an upper bound of 0.25%, but they passed numerous programs (PMCCF, SMCCF, TALF, MMLF, CPFF, etc.) in order to keep the credit markets functioning. While they may run out of acronyms at some point, they truly are injecting unprecedented amounts of support in the markets. Additionally, after some political wrangling, Congress passed a massive $2 trillion rescue package. The package is very wide reaching and a critical piece of legislation that will go a long way to help support businesses and citizens during such a troubling time.
While Target Rate moves tend to have a more immediate impact on the short end of the yield curve, yields on intermediate Treasuries decreased 125 basis points over the quarter, as the 10‐year Treasury yield was at 1.92% on December 31st, and 0.67% at the end of the quarter. The 5‐year Treasury decreased 131 basis points over the quarter, moving from 1.69% on December 31st, to 0.38% at the end of the quarter. Intermediate term yields more often reflect GDP and expectations for future economic growth and inflation rather than actions taken by the FOMC to adjust the Target Rate. There is no doubt that economic reports are going to be quite noisy over the balance of 2020. However, the revised fourth quarter GDP print was 2.1% (quarter over quarter annualized rate), and the current consensus view of economists suggests a GDP for 2020 around ‐1.3% with inflation expectations around 1.3%.
The global pandemic and crumbling oil prices were the main themes in the quarter leading to markets falling at the fastest pace everi. The energy sector was hit especially hard as crude fell from $60 to $20 a barrel. The price drop was due not only to demand destruction caused by the COVID‐19 economic fallout but also a supply side dispute between Russia and Saudi Arabia. An OPEC meeting broke down when Russia wouldn’t agree to production cuts. In a follow‐up move, Saudi Arabia decided that they would not only increase production but slash their selling price as well. The energy market has been reeling ever sinceii. Within high yield, the downgrades have been plentiful and the bankruptcies are beginning to trickle in.
Being a more conservative asset manager, Cincinnati Asset Management is structurally underweight CCC and lower rated securities. This positioning has served our clients well so far in 2020. As noted above, our High Yield Composite gross total return has outperformed the Index over the first quarter measurement period. With the market so weak during the first quarter, our cash position was a main driver of our overall performance. Further, our structural underweight of CCC rated securities was a benefit. Additionally, our underweight positioning in the communications sector was a drag on our performance. While our overweight positioning in energy hurt performance, our credit selections within the midstream industry performed much better than the sector. Unfortunately, our credit selections within the consumer cyclical services, leisure, and auto industries hurt performance. However, our underweight in the transportation sector and our overweight in the consumer non‐cyclical sector were bright spots. Further, our credit selections within the media and healthcare industries were a benefit to performance.
The Bloomberg Barclays US Corporate High Yield Index ended the first quarter with a yield of 9.44%. This yield is an average that is barbelled by the CCC‐rated cohort yielding 17.54% and a BB rated slice yielding 7.24%. Equity volatility, as measured by the Chicago Board Options Exchange Volatility Index (“VIX”), had the proverbial moonshot moving from 14 to a high of 83. For context, the average was 15 over the course of 2019. The first quarter had four issuers default on their debt, and the trailing twelve month default rate was 3.35%iii. Default rates are on the rise and the strategists on Wall Street are already bumping up their forecasts. Fundamentals of high yield companies have been mostly good and will no doubt be tested as we move through 2020. From a technical perspective, supply is still tracking higher than last year at this time even including the March shutdown of the primary market. High yield has certainly had trouble this year; however there are now many more opportunities present in the market than existed just three months ago. For clients that have an investment horizon over a complete market cycle, high yield deserves to be considered in the portfolio allocation.
With the High Yield Market trading at the current elevated spread level, it is important that we exercise discipline and selectivity in our credit choices moving forward. We are very much on the lookout for any pitfalls as well as opportunities for our clients. The market needs to be carefully monitored to evaluate that the given compensation for the perceived level of risk remains appropriate on a security by security basis. It is important to focus on credit research and buy bonds of corporations that can withstand economic headwinds and also enjoy improved credit metrics in a stable to improving economy. As always, we will continue our search for value and adjust positions as we uncover compelling situations. Finally, we are very grateful for the trust placed in our team to manage your capital through such an unprecedented time.
This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness.
i Wall Street Journal March 24, 2020: “Markets Melt Down at Fastest Pace Ever”
ii Wall Street Journal April 1, 2020: “Price War Batters OPEC’s Weak”
Investment grade credit just endured one of the most volatile quarters in the history of its existence. Most market participants would agree that only the 2007-2008 global financial crisis can compare to what we have experienced the past month. Spreads were humming along for the first two months of the year before they spiked to levels that had only been seen once since the 1988 inception of the Bloomberg Barclays US Corporate Index.
At its nadir on March 20, the index was down -10.58% year-to-date. For investment grade, in our view, this violent sell off was much less about credit than it was about liquidity and fund flows. Investors pulled a record amount of funds from bond markets over a two week period and the unbridled panic selling coupled with the proliferation of the liquidation of exchange traded funds led to a liquidity vacuumi. As a result there was very little in the way of orderly price discovery. It was perhaps, in our estimation, one of the worst times to sell in the history of the investment grade credit market and this was reflected in the prices of bonds that did sell during this time periodii. The tone in the market shifted substantially on Monday, March 23 as it seemed investors came to terms with the fact that yes, the challenges in front of us are enormous, and the economic data could be quite bad for some time, but humanity will persevere and the world will not end. The shift in tone led to a reversal in risk appetite and the Bloomberg Barclays US Corporate Index finished the quarter with a total return -3.63% while the S&P500 finished with a total return of -19.60%. This compares to CAM’s gross total return of -3.09%. We believe that policy actions by the Federal Reserve, and to a lesser extent, the passage of stimulus by lawmakers did much to restore confidence within the credit markets.
While we are not satisfied that the value of our portfolio declined during the quarter we feel that we are well positioned to weather an economic downturn. The portfolio has a significant structural underweight in BAA-rated credit and it is also underweight the energy sector and zero weight the leisure, gaming, lodging and restaurant industries, which have been particularly hard hit by the cessation of economic activity.
Overwhelming Supply and Outsize Compensation
We frequently speak of new issuance in our commentaries because it is the lifeblood of the corporate credit markets and one of the fundamental ways that fixed income investors acquire new investment opportunities. At CAM, during the invest-up process we will typically populate a new account with 20-30% new issuance as long as concessions from borrowers are attractive and we will also use these opportunities to add exposure for fully invested accounts that have cash available for reinvestment. There are companies constantly borrowing in the corporate bond market to fund capital allocation plans such as property, plant and equipment, liquidity or even shareholder returns. The month of March was one of the most interesting time periods for issuance that we have ever seen in our market and it was really a dichotomy of two halves. In first half of the month the primary market battled volatile treasury rates and record outflows from investment grade funds. According to data compiled by Bloomberg, through Friday, March 13, issuance stood at $37 billion. This was modestly lighter than street expectations to that point as volatility in both spreads and rates had kept issuers at bay. This all changed on March 17, as a myriad of high quality companies elected to take advantage of historically low Treasury rates and push through with issuance even despite historically high credit spreads. The new issue concessions offered during the two week period that would follow were the most attractive that the market has seen in over a decade with many concessions approaching 50-100bps relative to secondary offerings. As a colleague put it, the primary market was being dominated by borrowers who don’t need credit. What we saw were dozens of companies with extremely strong balance sheets borrowing to bolster liquidity in the face of economic uncertainty and they were willing to pay up to do so, but even if spreads where high, the borrowing costs that they were paying were still quite low when viewed through a historical lens. By the time the month had ended, March had rocketed to the top of the leaderboard for the busiest month in the history of the primary market with $259.2 billion in new supply. This was 46% higher than the previous record of $177.7 billioniii. Below you will find a table of all of the primary deals that CAM purchased for client accounts during the month of March.
As we turn the page to April we are still finding attractive concessions, but they are not what they were two weeks ago. We expect that volatility in credit spreads will come and go as the world battles through the current crisis but it is entirely possible that we may go a decade or more before we see primary market opportunities like the ones we saw the third and fourth week of March. This is why we constantly preach the need to have a long term strategic view for this asset class. A permanent allocation of capital is ideal in order to take advantage of opportunities like these when they do arise.
Fallen Angels and the Growth of BAA-rated Credit
One of the favorite topics of the financial press is back at the forefront, and for good reason, as it is a legitimate concern that could have a significant impact on the credit markets. In our discussions with investors we tend to find that there is fear surrounding fallen angels as it relates to the investment grade credit market but this is really a high yield problem, and it comes down to the size, depth and liquidity of the high yield universe relative to the investment grade universe. The face value of the investment grade universe is $6.7 trillion while the high yield universe is just over $1.2 trillion. The investment grade BAA-rated universe is over $3.4 trillion, almost three times the size of the
entire high yield universeiv. According to research by J.P. Morgan, they expect a record $215 billion in high grade debt could fall to high yield in 2020, driven predominantly by the energy and automotive sectorsv. This is not a problem for investment grade in general as these bonds are simply leaving the investment grade universe. It could be a problem for the bondholders of those companies who are downgraded and for high yield investors who are beholden to an index and must purchase the downgraded bonds of investment grade companies whether they like them or not.
As far as CAM’s positioning, we limit our exposure to BAA-rated credit at 30%, while the investment grade universe is more than 50%. Although we are significantly underweight BAA-rated credit we do allow the portfolio to hold split rated credits. Most often this is because it is a credit with just one or two investment grade ratings that is on its way to becoming fully investment grade but sometimes it is a fallen angel that we will continue to hold. There are two reasons we would continue to hold a fallen angel, it could be that we expect a full recovery to investment grade or we could be positioning for a more opportunistic sale. It is important, in our view, to never put the portfolio in a
position where it is a forced seller of a bond as a forced sale usually amounts to an ill-timed sale. We did have one credit in our portfolio get downgraded to fallen angel status during the month of March and we have elected to hold it for the time being as our research indicates that the pricing of the bonds is significantly below the fair market value. We expect more volatility in the BAA-rated portion of investment grade as we navigate economic uncertainty and
we expect our underweight will serve us well from a relative performance perspective.
Fed to the Rescue
The actions of the Federal Reserve have been extremely beneficial to the restoration of confidence in the bond markets. On Monday, March 23 the Fed announced a primary market and a secondary market corporate credit
facility. These actions were in response to turmoil within the commercial paper market and lack of liquidity for bond ETF redemptions. The timing could not have been better as the market ended the previous week with an extremely heavy tone so it was a moment of much needed confidence and the Fed stepped up and delivered exactly what was needed.
Tomorrow and Beyond
Tomorrow brings uncertainty; of that much we are certain. We expect continued volatility, particularly in the energy sector and in lower quality BAA rated credit. We are also optimistic and hopeful. We believe that we will come together, not just as a country, but as a civilization, to defeat the global pandemic. We take comfort in the fact that thousands of the smartest people in the world are currently working on solutions. We do not expect it to be easy and it may even take longer than expected but we know that we will eventually prevail. We believe now that a recession is inevitable so our credit selection is even more discerning than it usually is though we always look to position the portfolio in a manner to ensure it can perform through a full market cycle. A big question on investors’ minds is what will the recovery look like? Our view is that it will probably be less of a “V” and more of a “U” making credit selection paramount as it is important that companies within the portfolio have the balance sheet wherewithal to navigate an extended recovery.
We are sanguine on the current valuation of credit spreads. After closing at a high of 373 on March 23, the OAS on the corporate index ended the quarter at 272. This compares to the 5yr average of 128, the 10yr average of 140 and the average since 1988 inception of 135. Clearly credit has been repriced for the challenges that lie ahead and it has become a “credit pickers” market where a skilled active manager can make a difference.
As always please do not hesitate to call or write us with questions or concerns. We hope that you and your loved ones remain in good health during this difficult time.
This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness.
The information provided in this report should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this report or that securities sold have not been repurchased. The securities discussed do not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable, or that the investment decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein.
i The Financial Times, March 19, 2020 “Asset manager rocked by record bond outflows”
ii Institutional Investor, March 19, 2020 “The corporate bond market is “basically broken” Bank of America says”
iii Bloomberg, April 1, 2020 “IG ANALYSIS US: Record setting March ends with $13 billion bang”
iv ICE BAML Index Data, April 1, 2020
v J.P. Morgan, March 23, 2020 “Fallen angel risk in this crisis”
Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were +$5.9 billion and year to date flows stand at -$18.9 billion. New issuance for the week was $0.6 billion and year to date issuance is at $72.1 billion.
(Bloomberg) High Yield Market Highlights
The U.S. junk bond market is springing back into action with more companies looking to issue debt. Investors poured cash into U.S. high-yield funds with an influx of $5.9 billion.
Borrowers have started testing risk appetite again with sales of senior secured bonds as the leveraged loan market remains on ice, according to one high-yield syndicate banker
Junk bonds may slip Friday as stock futures fall following disappointing economic data from Europe and ahead of March payrolls that are expected to decline for the first time since 2010
A jump in oil prices may lend some support with the OPEC+ coalition pushing for other major oil producers to join it in a deep reduction of global crude output
Junk-bond yields rose 4bps to 9.77% but have dropped by more than 190bps from 11.69% on March 23. Spreads widened 10bp to +919bps
Junk-bond returns were negative for the second day, with 0.37%
CAA yields fell 9bps to 18.04% and spreads tightened to +1,772. Posted losses of 0.6%
(Bloomberg) Investors Clamor for Credit With New Deal Demand Off the Charts
Investors are meeting a flood of corporate debt issuance with even greater demand, a strong sign for risk appetite as issuers continue to bring new deals.
YUM! Brands Inc., bringing the first U.S. high-yield offering in nearly a month, already boosted the size of its deal to $600 million from $500 million amid $3 billion of orders. Oracle Corp., which was downgraded by two credit raters after announcing a deal Monday, has amassed more than $50 billion in orders for what could now be at least a $15 billion offering, according to people with knowledge of the matter.
Credit markets are showing signs of thawing, as strong reception of record investment-grade issuance has trickled into the high-yield market. While market access was initially limited to only top-notch firms like Exxon Mobil Corp. and PepsiCo Inc. just two weeks ago, investors have since gotten more comfortable with riskier names, and massive demand has cut down borrowing costs.
Last week, U.S. companies borrowed a record $109 billion, met with $550 billion of demand, in what one dealer called a “food fight” for new bonds. It was a similar story in Europe, where investors placed more than 310 billion euros ($340 billion) of orders for about 75 billion euros of bonds.
“As corporates should remain keen on retaining liquidity to weather the growing pain of lockdowns, we expect issuance windows to continue to attract issuers,” Commerzbank strategists said in a note to clients this morning.
YUM! Brands is bringing the first junk bond sale since March 4, one of the most positive signs of the recovery in credit to date. The investment-grade market continues to be active, with 12 deals in the market as of 12:49 p.m. in New York on Monday.
Airlines worldwide raised more than $17 billion in bank loans in March to shore up finances as the coronavirus grounds flights, with U.S. carriers like Delta the most active.
This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness.
The investment grade credit markets experienced another week that was largely positive in nature, although spreads are still wide to historical averages. Bright spots included tighter spreads and higher commodity prices. The spread on the Bloomberg Barclays US Corporate Index closed Thursday at 279, 16 basis points tighter from the end of the week prior. The tone is mixed as we go to print on Friday morning amid a brutally high unemployment report.
The primary market continues its record breaking pace. Not only was March the busiest month for new issuance on record with $259.2 billion in volume, but this week also set the record for weekly supply with $110.9 billion through Thursday; and it is not yet over with several deals in the market on Friday morning. Last week has now fallen to the #2 spot in the record books as this was the second week in a row of record breaking supply. Issuance this week was led by Oracle who printed $20bln on Monday and T-Mobile with a $19bln print on Thursday that boasted an order book of $74bln. The majority of issuers to this point are still comprised of companies that would be considered high quality borrowers. These companies are simply acting in a prudent and reasonable manner, shoring up their balance sheets amid an environment of uncertainty.
Investment grade credit was hit outflows again but a substantially smaller amount than in prior weeks. According to data compiled by Wells Fargo, outflows for the week of March 26-April 1 were -$4.6bln which brings the year-to-date total to -$32.5bln. As we have alluded to in previous commentaries, flows can do a lot to help stabilize the market and if they turn positive then the path of least resistance is tighter credit spreads.
This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness.
Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were -$2.0 billion and year to date flows stand at -$24.9 billion. New issuance for the week was zero and year to date issuance is at $71.5 billion. (Bloomberg) High Yield Market Highlights
U.S. junk bonds are off the lows after this week’s strong gains but may struggle as equity markets falter. Spreads have backed off from the 1,000 bps distressed level where they started the week, and robust ETF inflows help boost sentiment.
Investors pulled $2b from retail funds in the week. This was the sixth straight week of outflows from U.S. high-yield funds
Junk yields dropped below 11% to close at 10.33%, down 67bps, the biggest decline in percentage terms since June 2000
Spreads closed at 959bps after the biggest drop in nine months
Returns were up for three consecutive sessions
BB yields fell 44bps to close at 8.31% and spreads tightened 45bps at +746
Single-B yields fell 84bps to 10.01%, the biggest drop since 2008, and spreads tightened the most in nine months, to 937bps
Energy sector yields dropped 63bps to 22.38%, the third day of decline and the longest declining streak in 10 weeks
Spreads tightened for a foruth straight session closing at +2,161, down 54bps, the longest declining streak in 11 weeks
(Bloomberg) What’s in Congress’s $2 Trillion Coronavirus Stimulus Package
The bill provides direct help to citizens, businesses, hospitals and state and local governments.
Big Businesses: About $500 billion can be used to back loans and assistance to companies, including $50 billion for loans to U.S. airlines, as well as state and local governments.
Small Businesses: More than $350 billion to aid small businesses.
Hospitals: A $150 billion boost for hospitals and other health-care providers for equipment and supplies.
Individuals: Direct payments to lower- and middle-income Americans of $1,200 for each adult, as well as $500 for each child. Senate Minority Leader Chuck Schumer said checks would be cut April 6.
Unemployed: Unemployment insurance extension to four months, bolstered by $600 weekly. Eligibility would be expanded to cover more workers.
Restrictions on Business Aid: Any company receiving a government loan would be subject to a ban on stock buybacks through the term of the loan plus one additional year. They also would have to limit executive bonuses and take steps to protect workers.
Transparency: The Treasury Department would have to disclose the terms of loans or other aid to companies, and a new Treasury inspector general would oversee the lending program.
(Bloomberg) Distressed Debt Balloons to Almost $1 Trillion, Nears 2008 Peak
The amount of distressed debt in the U.S. has quadrupled in less than a week to nearly $1 trillion, reaching levels not seen since 2008 as the collapse of oil prices and fallout from the coronavirus shutters entire industries across the globe.
In total, the tally has ballooned to $934 billion of U.S. corporate bonds that yield at least 10 percentage points above Treasuries and loans that trade for less than 80 cents on the dollar, according to data compiled by Bloomberg.
The coronavirus pandemic has caused the worst sell-off since the global financial crisis and deepened stress in credit markets. Driven by some of the lowest oil prices since the early 2000s, the amount of distressed bonds has surged to the highest level since April 2009.
Most of the distressed debt outstanding stems from U.S. energy companies battered by less travel demand and an all-out price war between Saudi Arabia and Russia. The capital-intensive industry, which financed its shale production largely through debt, suddenly faces the prospect of deeper losses after oil plunged below $20 a barrel. Last month, it traded above $50.
The amount of distressed debt tied to the oil and gas sector stands at over $161 billion, up from $128 billion a week ago. One of the biggest casualties has been Occidental Petroleum Corp., which has seen its funding costs skyrocket and its credit rating cut to make it the biggest fallen angel in the current downgrade cycle. Oxy’s bonds led the list of high-yield losers on Wednesday, with four of its issues among the top 10 decliners.
Energy isn’t alone. Every sector except utilities is under stress, with distressed ratios growing by double or triple digits. Telecommunications, retail, entertainment and healthcare industries make up the bulk of distressed debt. Retailers such as Neiman Marcus Group Inc. and theater chains such as AMC Entertainment Holdings Inc. have been hit hard as companies are forced to close and customers are told to stay home.
S. junk bonds entered distressed territory for the first time since the global financial crisis after spreads on the securities topped 1,000 basis points at the end of last week. The index move marks a period of turmoil in the credit markets as investors flee funds that buy all types of corporate debt.
(Bloomberg) Ford Becomes Largest Fallen Angel After S&P Downgrade to Junk
Ford Motor Co. was cut to junk by S&P Global Ratings as the coronavirus pandemic delivers a shock to the global auto industry and renders the carmaker the largest fallen angel to date.
S&P downgraded Ford’s credit rating one notch to BB+ and may cut it further, according to a statement. The move follows Moody’s Investors Service, which dropped its rating Ford for the second time in sixth months earlier Wednesday. Its two high-yield ratings will remove its $35.8 billion of debt from the Bloomberg Barclays investment-grade index at the end of the month.
Ford is one of many auto companies facing what Moody’s calls an unprecedented “credit shock,” with the coronavirus outbreak also posing a major threat to peers including General Motors Co. and Volkswagen AG. But Ford is particularly at risk because of the problems it’s been having with executing an $11billion restructuring that’s yet to improve performance.
“Ford is managing through the coronavirus crisis in a way that safeguards our business, our workforce, our customers and our dealers,” the company said in an emailed statement. “We plan to emerge from this crisis as a stronger company.”
This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness.
What a difference a few days makes. The investment grade credit market, like equities, went out with a whimper last week. On Monday, with the stimulus package in limbo, a deluge of supply pushed spreads out to their widest levels of the year, and the Bloomberg Barclays Corporate Index closed at 373. The next few days saw a much improved tone, and even in the face of a historically large primary calendar, spreads ratcheted in 71 basis points to close Thursday at 302. To put this 71 basis point move into context, it was larger than the yearly range of the corporate index for each of the preceding three years, and it took only three days; truly a stunning reversal. Even with the improved tone, through Thursday, the index was down -5.96% year-to-date while the S&P 500 was down -18.21%.
The primary market continues to bustle with activity and through Thursday it easily smashed the record for its busiest week in history. $98.9 billion had priced through Thursday eclipsing the previous weekly record of $74.8 billion, according to data compiled by Bloomberg. There are several deals in the market as we go to print on Friday morning which will push the final weekly total north of $100 billion. The bulk of the issuance this week was from highly rated issuers with “A” credit ratings but we started to see some BAA-rated issuers get into the mix as the week wore on. There is one lower quality BAA issuer in the market on Friday morning which is really the first of its kind in recent weeks so we will get an idea about how the market feels about lending to more challenged credit stories.
Investment grade credit was hit with major outflows for the fourth consecutive week. Flows for the week of March 19-25 were -$43.3bln according to data compiled by Wells Fargo. The four week total was nearly -$100bln. Year-to-date flows are now negative to the tune of -$28bln. We would like to think that with an improved tone that many of the panic sellers and leveraged fast money has exited a space that is more suited for strategic permanent capital. Improving flows can only help to further strengthen the tone in the credit markets.
This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness.
We hope this commentary finds you all safe and healthy. We wish we would be able to provide you more frequent commentary however things have been changing so rapidly that any update we could provide would have been deemed irrelevant by the time the ink dried on the page. We will seek to provide you with commentary weekly or as is relevant.
The investment grade credit market has just capped off one of the most volatile two week periods in the history of its existence. The impact of a global pandemic as well as the Saudi-Russia oil standoff has weighed heavily on risk assets of all stripes, and although high quality investment grade typically behaves as a safe haven, even it has not been able to escape the grasp of panicked sellers. Through the week ended March 20, the YTD gross total return on the Bloomberg Barclays US Corporate Index was -10.58%. For context, the S&P 500 was down -28.33% over the same time period. CAM does not provide intra-monthly performance for our portfolios but we are generally more conservatively positioned relative to the corporate index. Recall that CAM has a significant structural underweight on BAA-rated credit by capping our exposure at 30% while the index has a BAA concentration of nearly 50%. CAM also targets a minimum rating of A3 for its portfolio. In a risk off panic, such as the one we have experienced as of late, it is BAA-rated debt that typically underperforms relative to A-rated debt and that has been consistent with what the market has experienced so far in 2020. Year-to-date, A-rated credit has outperformed BAA-rated credit as spreads on the A-rated portion of the index have widened 270 basis points while BAA-rated credit has underperformed to the tune of 46 basis points, having widened 316 basis points thus far in 2020. The AAA/AA portion of the corporate index has held up even better, having outperformed the BAA-rated portion of the index by 126 basis points year to date on a spread basis. To be sure, a pandemic driven global recession is not bullish for investment grade credit, however, it is important to remember that we are talking about high quality investment grade rated companies. This portion of a portfolio is designed to be the ballast that, over time, will reduce volatility and correlations with other asset classes in the context of a well-diversified portfolio. A recession is not good for any asset class and there will be some investment grade companies that are more affected than others. By and large the majority of these companies will see themselves through to the other side and the vast majority of companies will continue to pay interest and debts owed to bondholders. It is also important to remember that, in the framework of a capital structure, bondholders are ahead of equity holders as it is the bondholders that have first claim on the assets of a company. We are already seeing numerous companies change their behavior by suspending share buybacks and cutting dividends in order to protect their balance sheets so that they can continue to make good on their financial obligations that are not negotiable – payments to bondholders.
As far as our portfolio positioning is concerned, we are not infallible and we have some credits that have been impacted by the economic consequences of the pandemic. We are closely monitoring these situations as we always do. We are fortunate in that we have zero exposure to gaming, lodging, leisure or restaurants, as these have been particularly hard hit by the pandemic. We have some exposure to the energy sector but we are materially underweight relative to the corporate index. We have some exposure to airlines but no exposure to unsecured bonds – our only exposure to airlines is through bonds that are secured by the aircraft themselves. Our high quality bias and our bottom up research process leaves us feeling positive about the positioning of our portfolio relative to the index and we are constantly monitoring the portfolio for opportunities to better position, which for us usually means to more conservatively position.
Market Recap
Remarkably, the investment grade primary market remains alive and well as the week of March 16-20 ended up as the third busiest of all time with 23 borrowers bringing over $62bln in new debt. This flurry of issuance was important for the psyche of the market in our view as it once again proved that the investment grade market is never closed to high quality issuers. This was true during the depths of the financial crisis and it is true now. So why, may you ask, would issuers choose to print deals amid such volatility? First, it is really just the prudent thing to do if a company has access – faced with an uncertain near term economic outlook; it makes sense to bolster the balance sheet. Second, due to the drop in Treasuries, debt remains cheap. Take Coca-Cola for example, which was able to issue 10yr debt with a coupon of 3.45% on Friday. That is a very reasonable interest rate when viewed through a historical context. It is also reasonable compensation for investors who are faced with declining yields throughout the world.
Flows have not been the friend for credit investors with long time horizons these past two weeks and the flows themselves have been an even bigger driver of performance than the pandemic in our view. Outflows from IG credit for the week of March 12-18 were an eye-watering -42.7bln according to data compiled by Wells Fargo. This represents the largest outflow on record and is nearly 5x larger than the previous record for a weekly outflow. Investment grade credit is liquid, especially compared to the majority of other fixed income products, such as municipals, but it is not liquid enough to withstand an outflow of this magnitude without serious dislocation, and that is exactly what occurred over the past week. Liquidity for investment grade was easily as bad as it has been since the financial crisis and quite possibly worse based on the opinion of our team at CAM. To be clear, yes the pandemic will weigh on credit metrics for many IG companies, but the underperformance of the IG market over the past week was much more about flows than concerns about creditworthiness. This was panic selling plain and simple. If the market gets to a point where flows are positive or even neutral then the path of least resistance is tighter spreads. The dislocation has created opportunity for committed investment grade buyers especially at the front end of the curve as you can now purchase the 5-6-7 year bonds of some issuers at yields that are greater than their bonds that mature at 10yrs and beyond.
The Federal Reserve continues to act aggressively and decisively as it announced support for numerous market segments on Monday morning. Of particular interest to us is that the Fed will now be buying investment grade rated corporate bonds. The Fed will operate a Primary Market Corporate Credit Facility and a Secondary Market Corporate Support Facility. Through the Primary Facility the Fed will purchase IG rated corporate bonds with maturities of 4 years or less. Through the Secondary Facility, the Fed will purchase IG rated corporate bonds maturing in 5 years or less and it will also be providing liquidity for fixed income ETFs which should go a long way to correcting some of the price discovery problems we saw in the IG market last week. This package by the Fed had the immediate effect of driving IG credit spreads significantly tighter, but more importantly than that it gave the market some much needed confidence. The next step to instilling some semblance of calm into the capital markets would be the passage of a substantial relief package by the Senate. They failed to come to an agreement Sunday evening and for the second time Monday afternoon but we are hopeful that they will come to terms by the end of this week.
As we continue to navigate these turbulent times we wish the best for the health of you and your families. Thank you for your continued interest.
This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness.
