Goldman Sachs warns of US$2 trillion ‘corporate debt wall’

An impending “corporate debt wall” of more than US$2 trillion is about to impact on the US economy over the next two years, according to Goldman Sachs.

The bank warned in a note that higher interest expenses tied to the refinancing of US corporate debt will lead to a reduction in capital expenditures and the loss of about 5,000 jobs per month in 2024. That figure could double in 2025 to 10,000 jobs per month, should interest rates remain elevated at their current level.

“If interest rates remain high, companies will need to devote a greater share of their revenue to cover higher interest expense as they refinance their debt at higher rates,” said Goldman Sachs’ chief economist Jan Hatzius. “We find that for each additional dollar of interest expense, firms lower their capital expenditures by 10 cents and labour costs by 20 cents.”

Until the Federal Reserve began hiking interest rates in early 2022, US companies benefited immensely from the period of low rates. According to Bank of America, the debt composition of Standard & Poor's (S&P) 500 companies included as many as 76% in long-term fixed debt, much of which was secured at low single-digit rates.

But with US interest rates now at 5.25-5.50%, and potentially set to go higher still as the Federal Reserve contginues to combat inflation, refinancing risks will grow more pronounced, especially over the next two years.

Goldman Sachs predicts that corporate debt maturities will be US$230 billion for the rest of 2023, US$790 billion in 2024, and US$1.07 trillion in 2025, representing a combined 16% of all corporate debt. A further US$4+ trillion in corporate debt is set to mature from 2026 through 2030, according to Goldman.

Companies that will be hit hardest by refinancing debt at higher interest rates are the less profitable ones, which typically rely more heavily on firings to balance costs.

“Our estimates suggest about half of the reduction in labour costs comes from reduced hiring and half from lower wage growth, implying a 5,000 drag on monthly payrolls growth in 2024 and a 10,000 drag in 2025,” Hatzius said.

The debt refinancing wall indicates that it could take years for the Fed’s aggressive interest rate hikes to make its way through the economy and impact businesses and might also help explain which the US has so far avoided a recession. 

“The limited refinancing needs since the start of the Fed's tightening cycle suggest that the impact of higher interest rates on growth is more delayed than the average historical impact that our Financial Conditions Index impulse model project,” Hatzius said.

 

Italy's banks face 40% windfall tax

Italy’s right-wing government has upset the markets with an unexpected tax on banks’ windfall profits, sending shares in the country’s leading lenders down when trading in Milan opened on Tuesday.

Deputy Prime Minister Matteo Salvini announced a 40% levy on the extra profits of lenders for 2023 late Monday night, as part of a wide-ranging decree approved at a cabinet meeting. Analysts at Citi estimate it will wipe 19% from banks’ net profits for the year, based on currently available data.

“We see this tax as substantially negative for banks given both the impact on capital and profit as well as for cost of equity of bank shares,” Citi said.

Salvini told a press conference that the 40% levy on banks’ extra profits derived from higher interest rates, amounting to several billion euros, will be used to cut taxes and offer financial support to mortgage holders.

“One only has to look at the banks’ first-half 2023 profits, also the result of the European Central Bank’s (ECB) rate hikes, to realise that we are not talking about a few millions, but we are talking one can assume of billions,” Salvini said.

“If [it is true that] the cost of money burden for households and businesses has increased and doubled, it has not equally doubled what is given to current account holders.”

The tax will apply to “excess” net interest income (NII) in both 2022 and 2023 resulting from higher interest rates and will be applied on NII exceeding 3% year-on-year growth in 2022 from 2021 levels, and exceeding 6% year-on-year growth in 2023 versus 2022. Banks are required to pay the tax within six months after the end of the financial year.

“The introduction of this tax (which was discussed, then left pending) could lead to Italian banks increasing their cost of deposits in order to reduce the extra profit, and this comes after a round of results when every bank increases 2023 guidance for NII and assuming a slowdown of growth in 2H (due to raising deposit beta, even if expectation below previous guidance),” Citi said.

“It is not clear whether the tax will apply to domestic NII only (we base our simulation on this), and this could have larger impact for UCI vs. peers (given international franchise).”

 

US investors regain appetite for riskiest corporate debt

Investor, who earlier this year were avoiding the riskiest US corporate such as the lowest-rated junk bonds, have quickly regained their appetite, reports the Financial Times. It adds that optimism about the state of the world’s largest economy has narrowed the gulf between the top and bottom range of the US$1.35 trillion junk bond market.

The gap between the yield on double-B and double-C bonds recently narrowed to the tightest level in 15 months at 6.53 percentage points, before widening slightly to 6.74 percentage points at the end of last week – underscoring investors’ growing confidence that the US can avoid a recession despite the Federal Reserve raising interest rates 11 time since March 2022.

Such hopes of a “soft landing” follow a flurry of positive data, with persistent evidence of easing inflation and better-than-expected second=quarter US growth figures.

The shrinking gap between the top and bottom of the junk debt market – a closely watched barometer of US investors’ risk appetite – contrasts with the aftermath of the failure of two US regional banks in March, which compounded fears of a recession and piled pressure on highly indebted companies’ bonds. The spread between double-B and triple-C bonds widened to 8.52 percentage points in April as investors avoided debt issued by companies most at risk of default in the event of an economic downturn.

“A few months have passed without more bank failures after First Republic,” commented Marty Fridson, chief investment officer of Lehmann Livian Fridson Advisers, referring to the collapse of another lender in May. Many investors also believe that the Fed implemented its final interest rate hike in July, he added. “They’re clinging to that idea, even if [Chair Jay Powell] didn’t give a clear message that they’re done.”

Yields and spreads on junk bonds remain far higher and wider than their lows in 2021, when Fed stimulus was still supporting the financial system. Valuations have also been supported this year by a shrinking market, investors say, with upgrades to investment grade territory and relatively low new issuance anchoring prices at artificial levels.

 

PayPal to launch a stablecoin

PayPal Holdings announced that it is rolling out a stablecoin, the first by a major financial company and a potentially significant boost to the sluggish adoption of digital tokens for payments.

PayPal USD (PYUSD) is issued by blockchain development fintech Paxos Trust Co and fully backed by US dollar deposits, short-term Treasuries and similar cash equivalents, the San Jose, California-based payments company said. It is pegged to the dollar and will be gradually made available to PayPal’s customers in the US.

Customers will be able to use PYUSD to purchase products, send from person-to-person, transfer to other wallets, and can be converted to or from other cryptocurrencies that PayPal supports.

“The shift toward digital currencies requires a stable instrument that is both digitally native and easily connected to fiat currency like the US dollar,” said Dan Schulman, president and CEO, PayPal. “Our commitment to responsible innovation and compliance, and our track record delivering new experiences to our customers, provides the foundation necessary to contribute to the growth of digital payments through PayPal USD.”

The planned launch comes soon after the Republican led House Financial Services Committee passed legislation at the end of July to regulate stablecoins. That legislation would permit companies like PayPal to issue stablecoins; something that Democrats are opposed to.

 

Ripple launches open data platform for carbon market

Blockchain firm Ripple said that it plans to the power of technology for climate change mitigation, through a partnership with a newly-formed climate-focused technology provider..

An announcement issued by Ripple stated: “In collaboration with RMI (Rocky Mountain Institute), a pioneer in sustainable investing, Ripple is excited to introduce a new company Centigrade.

“Centigrade is an open data platform serving the global carbon and nature markets. The platform will provide developers of carbon and nature credits with a low-barrier, intuitive way to bring their projects to market, providing full data transparency and traceability for the entire lifecycle of credits. It aims to open global credit markets to all carbon and nature developers—regardless of size and location—and boost the availability of capital needed to scale carbon removal and nature restoration projects to the required level.”

Carbon markets—mechanisms enabling the trade of carbon credits to offset CO2 emissions—have traditionally suffered from opacity and scepticism. The new platform promises to “instil trust in the global voluntary carbon markets…. and foster a liquid, fair and efficient carbon market.”

In May 2022 Ripple announced a US$100 million commitment to climate change mitigation and said that the funds would aid in the upgrading of the carbon credit market.
 

Heartland Tri-State Bank closed by US regulator

Small town USA bank Heartland Tri-State has become the latest American regional bank to fail. The Kansas banking regulator closed the bank late last month and appointed the Federal Deposit Insurance Corporation (FDIC) as the receiver.

The FDIC announced: “To protect depositors, the FDIC entered into a purchase and assumption agreement with Dream First Bank, National Association, of Syracuse, Kansas, to assume all of the deposits of Heartland Tri-State Bank.”

“We declared the bank insolvent because of a scam they fell victim to,” said Kansas state bank commissioner David Herndon. “I can’t speak to the particulars of that. Investigations are ongoing. But it had nothing to do with interest rate increase. Nothing to do with balance sheet asset quality. Nothing to do with the Fed.”

Heartland Tri-State’s demise attracted less attention than US  earlier this year, such as Silicon Valley Bank. Heartland Tri-State was a small institution with just US$139 million in assets and was purchased by Dream First, a local competitor formerly known as First National Bank of Syracuse. The cost of the closure to the FDIC’s deposit insurance fund is estimated at US$54 million or more than the size of the entire US$48 million loan book.

The four branches of Heartland Tri-State reopened as branches of Dream First Bank, National Association at the start of last week.

 

Australia watchdog blocks ANZ-Suncorp merger

The Australian Competition and Consumer Commission (ACCC) has withheld authorisation for Australia and New Zealand Banking Group (ANZ) to acquire Suncorp Group’s banking division citing concerns over SME lending and mortgage competition.

The ACCC adjudicated that Australia’s non-Big Four domestic banks such as Suncorp and Bendigo Adeliade are important competitors against the majors, especially because barriers to entry at scale into banking are elevated as evidenced by the failure of neobanks to gain a foothold in recent years with the exception of Judo Bank. The decision was issued following lengthy delays frustrating both parties despite the Queensland government supporting the merger.

ANZ has committed to take its acquisition plans to the tribunal after the ACCC rejected the A$4.9 billion (US$3.2 billion) acquisition on fears it would “further entrench an oligopoly” and lead to reduced competition in mortgage lending, agribusiness and small business banking in Queensland.

“We are not satisfied that the acquisition is not likely to substantially lessen competition in the supply of home loans nationally, small to medium enterprise banking in Queensland, and agribusiness banking in Queensland. These banking markets are critical for many homeowners and for Queensland businesses and farmers in particular. Competition being lessened in these markets will lead to customers getting a worse deal” commented ACCC Deputy Chair Mick Keogh.

 

UK’s Shawbrook and Co-operative Bank plan £3.5 billion merger

Private equity-backed UK small business lender Shawbrook has tabled a stock-based proposal to combine with the Co-operative Bank..

Weekend reports said that Shawbrook had recently approached the owners of the Co-operative Bank to outline proposals for a £3.5 billion (US$4.5 billion) stock-based combination of the two companies.

The preliminary proposal is thought to represent an attempt by Shawbrook to pre-empt a full auction of the erstwhile division of the Co-op Group. It comprised an offer to hand the Co-operative Bank's shareholders around 29% of the combined banking group in a deal that would have valued the target at approximately £800 million.

Shawbrook has hired investment bankers at Barclays to advise it on its interest in its smaller, consumer-focused peer, but sources suggested that the indicative offer was unlikely to lead to further talks ahead of a wider auction.

Shawbrook remains interested in a takeover of the Co-operative Bank and is expected to participate actively in that process, which will formally get underway next month.

On a combined basis, Shawbrook and the Co-operative Bank reported underlying profit last year of nearly £375 million. A tie-up between the two would rank among the most significant UK banking sector deals since the 2008 financial crisis.

 

More ESG lawsuits loom as investors utilise UK law

Investors are increasingly resorting to filing legal challenges against companies for their net zero claims, approaches to governance and other topical environmental, social and governance (ESG)-related issues, using a pair of underutilised provisions of a UK law, reports Bloomberg.

 Standard Chartered, telecoms operator BT Group and mining giant Glencore were among those sued last year for alleged governance or social-related shortcomings as investors turned to the courts to boost corporate sustainability. Sections 90 and 90A of the UK's Financial Services and Markets Act 2000 (FSMA) state that a company can be liable to pay compensation if it makes a misleading statement or an omission in public filings and the UK shift is part of a global uptrend in ESG-related lawsuits.

“Claims under section 90 and section 90A of the FSMA are a fast-growing area, providing investors with an avenue of redress should they consider that a public company has misled them in respect of its public disclosures,” according to a recent analysis by the law firm Bryan Cave Leighton Paisner. “As class actions gain a foothold in England and Wales, these claims are increasingly being used by investors and shareholders to seek to recoup their losses and hold public companies to account.”

Sarah May and Michael Radcliffe of Grant Thornton recently commented that while having the ‘right’ ESG strategy can be instrumental to a company’s success, getting it wrong can lead to reputational damage, regulatory investigations, and fines or litigation.

“In February 2023, the UK Competition and Markets Authority (CMA) published draft guidance intended to provide more certainty on antitrust risk for businesses that enter into agreements aimed at achieving environmental goals, the latest in a stream of green codes and guidance issued by regulators over the last few years,” they add. “We have recently seen regulators start to crack down on greenwashing violations and there has been a steady rise in climate change-related litigation, with the number of cases doubling since 2015.

“We expect this increase in regulatory investigations and litigation to continue given the current focus on ESG issues, an increase in related regulations and disclosure requirements, as well as increasing access to third-party funding, which enables individuals and classes of individuals to bring claims which they otherwise may not be able to.”