Why US corporate bond defaults are set to rise– Industry roundup: 4 August
by Graham Buck
US corporate bond default rates set to climb
Default rates in the US corporate bond market hit all-time lows near zero in 2021 but have started to edge higher, according to the axios.com website. “With recession worries hitting a fever pitch, the question isn’t whether defaults will rise — it’s how high they’ll go, and how much damage that'll inflict on investors,” it comments.
Axios cites a forecast by Kroll Bond Rating Agency (KBRA) Analytics that the US high-yield bond default rate a year from now will be around 3.76%, which would represent a major spike from the current figure of 0.40% and also surpass the historical mean of 3.61%.
“We are in a post-Covid world, and everything is kind of going back to normal,” Van Hesser, KBRA's chief strategist, told Axios. “Now the question is: what follows?”
The capital markets have already all but cut off the lowest-quality issuers that have only “CCC” credit ratings. Constrained access to capital is usually an early sign that defaults is about to rise. Last month Bank of America (BoA) Research noted that a CCC-rated refinancing had not cleared the market since February, while Leveraged Commentary & Data (LCD) reports that overall high-yield issuance has slowed to a near-standstill.
The better news is that although past recessions have seen default rates spike above 10%, there is good reason for believing that they will climb less steeply in the upcoming default cycle – due in part to a pandemic-induced default cycle two years ago that cleared weaker companies out of the bond market.
In addition, last year’s extremely loose credit conditions enabled companies to virtually eliminate near-term maturities. Goldman Sachs estimates there are no more than US$125 billion of high-yield bonds maturing in 2023 and 2024 combined, although that figure rises to around US$200 billion per year from 2025 onwards.
Loose conditions in 2021 also mean companies can better afford their debt. A recent market commentary by Oaktree Capital Management noted that 36% of US high-yield bond issuers have a coupon of less than 5%, a claim that only 16% of issuers could make in December 2019.
Oaktree also noted that credit quality in the high-yield market has also improved over the past decade. Bonds with a credit rating of BB (the highest high-yield rating) now constitute 53% of the US high-yield bond market, up from 43% in 2012. Combined, those conditions may take the edge off the pain of the next default cycle but will not be enough to prevent it altogether, Axios concludes.
Half-point rise takes UK interest rates to 1.75%
The Bank of England’s monetary policy committee (MPC) has met market expectations by voting for a 0.5% increase in UK interest rates, the sharpest rise in borrowing costs since 1995.
Since last December, when the MPC voted to increase the rate from a historic low of 0.10% to 0.25%, it has followed up with four quarter-point increases but indicated in June that it would act more “forcefully” if needed. While UK economic growth has weakened markedly, inflation hit 9.4% in the year to June 2022 and the BoE has warned that it is likely to reach 11% in October.
However, think tank The Resolution Foundation believes that the BoE’s inflation forecasts need further upward revision following new projections on the price of wholesale gas. It has pencilled in a rate as high as 15% by early 2023.
At its August meeting earlier this week the Reserve Bank of Australia (RBA) bank lifted interest rates for the fourth time in a row, the first such series of consecutive increases since 1990.
Tuesday’s 0.5% increase took the cash rate to 1.85%, a cumulative rise of 1.75% since May and also the fastest increase since the 1990s. The RBA signalled there would be further increases to come. Analysts predict that the rate will continue to rise over the next four months, and some predict a cash rate of over 3% by the end of 2022.
Facebook parent Meta Platforms considers corporate bonds offer
Facebook’s parent Meta Platforms has asked banks to hold investor meetings for a potential bond sale, the company’s first, after previously shunning bond issuance.
According to reports, Meta requested that Morgan Stanley, JPMorgan Chase, Bank of America and Barclays set up a series of fixed-income investor, according to an anonymous source who added that a senior unsecured debt offering could follow.
Until now Meta has kept its distance from the bond market unlike many of its large-cap technology peers, which have borrowed heavily at low rates despite large cash piles. It is one of only 18 companies in the Standard & Poor’s (S&P) 500 without outstanding short or long-term debt, excluding lease liabilities, as of the most recent quarter, according to Bloomberg.
“Meta could build a new capital structure that includes its first-ever bonds, issuing well over US$10 billion to potentially benefit holders of both equity and debt, following weak first half results, and over a 50% drop in its equity value,” said Bloomberg Intelligence analyst Robert Schiffman. “Increased capital spending focused on the metaverse, along with rising share buybacks, could be supported with tens of billions of low-cost debt theoretically as 2022 free cash flow contracts.”
Meta currently has capacity to issue as much as US$50 billion of debt, according to BI and had around US $40.5 billion of cash and equivalents at the end of June. The company’s shares have fallen by 52% so far this year, reflecting increased competition from TikTok, economic concerns and investor disquiet over Chief Executive Officer Mark Zuckerberg’s incrasing focus on the so-called metaverse.
Traders “focus on the ‘G’ in ESG"
Many surveys have concluded that of the three ‘ESG pillars’ (environmental, social and governance), the first, environmental, carries the most weight with investors.
However, analysts at Bloomberg Intelligence recently asked head and senior traders at 93 European asset management firms, including hedge funds, about what matters most to their business: the E, S or G. Most traders responded that they find governance – the ‘G’ pillar – to be the most important.
Other traders suggested that trying to evaluate companies based on their combined environmental, social and governance credentials is a futile exercise as the terms are incongruous and should be assessed separately.
Bloomberg Intelligence (BI) comments: “Despite the various viewpoints, ESG has grown into an estimated US$35 trillion business with a plethora of investment products (and a growing consensus that many if not most of them do little if anything but pay lip service to ESG).
“With so much money to be made, asset managers everywhere are devoting more resources to building out their “sustainable” investing teams as more funds gravitate to the industry."
According to Larry Tabb, BI’s head of market structure research, unlike portfolio managers who are more focused on the environmental and social pillars, traders are most concerned about working with counterparties that maintain ethical standards, The last thing traders want is to get caught up in a regulatory quagmire.
The BI study focused on Europe because the region is seen as most advanced in adopting ESG principles. ESG investing has clearly “moved into the European mainstream from its role as a niche strategy,” said Jackson Gutenplan, a BI senior associate t BI who oversaw the survey.
Almost half of European asset managers surveyed expect to allocate a larger part of their budgets to ESG from a year earlier, he said. As regulations mount, none of the firms in BI’s study said they plan to spend less on ESG initiatives and compliance.
To avoid government scrutiny, many traders will shun business with firms that fail to meet specific codes of conduct, including data privacy, anti-corruption and ethical internal controls, or firms that fall under national sanctions, Gutenplan said.
The survey found that 87% of European buyside traders said governance is “important” or “very important” to their business, especially in vendor and counterparty relationships. Smaller firms, or those managing less than £1 billion (US$1.2 billion), allotted more importance to all three of the ESG components than their larger peers, said Gutenplan.
Only 12% of large firms overseeing more than £15 billion, ranked the environmental component of ESG as “very important,” compared with 39% for medium-sized firms and 47% for small firms.
In aggregate, social considerations rank as the least essential ESG pillar among traders, Gutenplan said. It’s considered the broadest category of ESG, with diversity weighing in as the most prominent issue. But social also includes topics such as operational health and safety, community rights and relations, customer welfare and marketing.
Solana wallets drained in latest crypto hit
The cryptocurrency market has suffered a further blow, with hackers targeting the Solana ecosystem and thousands of wallets affected after bridge protocol Nomad was attacked earlier this week.
Estimates of the damage vary, but between US$5.2-8.0 million in cryptoassets have been stolen so far from more than 7,900 Solana wallets, according to blockchain forensics firm Elliptic.
Solana has proved an increasingly popular blockchain, known for its speedy transactions. The attack was apparently focused on “hot” wallets or wallets that are always connected to the internet, allowing people to store and send tokens easily - but was apparently not limited to Solana.
Justin Barlow, an investor at Solana Ventures, reported that his USD Coin (USDC) balance was drained as well. Crypto analyst @Oxfoobar confirmed that “the attacker is stealing both native tokens (SOL) and SPL tokens (USDC)… affecting wallets that have been inactive for less than six months.”
The attack compromised other wallets including Phantom, Slope and TrustWallet. Wallets drained should be treated as compromised and abandoned, Solana warned as it encouraged users to switch to hardware or “cold” wallets.
Phantom, a fast-growing Solana-based wallet, said that it was “working closely with other teams to get to the bottom of a reported vulnerability in the Solana ecosystem.”
The Solana attack came shortly after malicious actors abused a “chaotic” security exploit to steal almost US$200 million in digital assets from cross-chain messaging protocol Nomad. The “free-for-all” attack, which saw more than 41 addresses drain US$152 million — 80% of the stolen funds — was made possible by a recent update to one of Nomad’s smart contracts that made it easy for users to spoof transactions.
Glencore’s profit surges on demand for coal
Glencore, the world’s biggest commodity trader, announced that it will return an additional US$4.45 billion to shareholders via a US$3 billion share buyback and US$1.45 billion dividend after its first-half profit more than doubled to a record thanks to surging coal prices.
As the world’s top coal shipper, Glencore has been a major winner from the global energy crunch as demand surges for fossil fuels. The company’s diverse trading business has also cashed in on dramatic price swings across markets from metals to oil following Russia’s invasion of Ukraine.
Glencore’s healthy profits and returns contrast with its mining rivals, which have reported falling earnings and reduced payouts on lower prices for commodities like iron ore and copper retreat. The company has often lagged behind its peers in recent years as it does not produce iron ore -- a key profit driver for mining groups BHP and Rio Tinto. Glencore has benefited from opting to stick with its coal business while other producers retreated from the dirtiest fuel.
First-half core profit rose to US$18.9 billion, including $9.5 billion from the unit that produces coal -- more than the entire business made a year earlier. Coal has soared to records this year as utilities curb imports from Russia due to the war in Ukraine, tightening the amount of available supply, while surging natural gas prices increase demand for other energy sources.
The company joined rivals by warning of growing headwinds in demand for its key commodities but said energy prices will stay high. “With few short-term solutions to rebalance global energy markets, coal and liquified natural gas (LNG) prices look set to remain elevated during this period, particularly given the current challenge of securing sufficient and reliable energy supply for the Northern Hemisphere winter ahead,” said Chief Executive Officer Gary Nagle.
Glencore’s trading unit earned US$3.7 billion in the first half of 2022, well above the top end of its guidance for the full-year, as soaring prices and volatility create arbitrage opportunities.
The bumper trading profits came at a short-term cost however -- the company said it invested an extra US$5 billion in the trading business, reducing the scope for shareholder returns. While surging commodity prices have helped fuel record profits for trading houses, the big daily swings have also become a liability, leading some small players to reduce their exposure.
Glencore is able tap its vast balance sheet and credit lines, but the company cautioned last week that the trading unit’s working capital needs had jumped, as it becomes more expensive to finance the shipment of commodity cargoes, and exchanges and brokers require additional cash to place and maintain hedging trades.
Glencore expects a more normalised trading performance in H2. Based on its long-term forecast range, that would put the trading business on track for about US$5 billion of profit in 2022.
While the war in Ukraine has fuelled record profits, it has also affected Glencore’s shareholdings in two of Russia’s biggest companies, En+ Group International PJSC and Rosneft PJSC. Glencore is writing down the value of those stakes to zero, taking a US$1.3 billion impairment in the process.
Treasure partners with Grasshopper on enhanced cash management
Californian B2B fintech company, Treasure Financial which provides automated cash management solutions for growing businesses, has partnered with New York-based Grasshopper Bank to deliver “a new platform where businesses can dynamically optimise the rate they are generating on their cash balances and have better vision into their financial health,” according to a release. “This bolsters Treasure’s treasury management solution offering and will help Grasshopper deepen relationships with its small to mid-sized business customers.”
Treasure said that its technology provides a full suite of products to help financial managers access financial products to help them generate revenue from their finances. In the new partnership, Treasure clients will now have access to Federal Deposit Insurance Corp (FDIC)-insured deposit products and payments capabilities by leveraging Grasshopper’s innovative Banking-as-a-Service (BaaS) platform, powered by API middleware provided by the Bank’s technology partner Treasury Prime.
“Treasure and Grasshopper are working together to help all businesses have access to the same type of financial services as large corporations,” the release continued. “This relationship is providing businesses with better yield production on their cash balance, more automation, and an easier way to move money. Treasure’s platform is positioned as the solution to optimise business finances in real-time without any friction. The two companies are continuing to explore ways to strengthen this relationship by potentially offering the Treasure solution to Grasshopper clients in the future.”
Ecospend and CDER partner on secure ‘Pay-by-Bank’ solution
Open banking technology provider Ecospend is partnering with CDER Group, the UK enforcement and debt resolution specialist, to provide its account to account ‘Pay-by-Bank’ solution.
“Collecting over £250 million of unpaid central and local government debt each year, CDER Group are using Ecospend’s ‘Pay-by-Bank’ solution to provide an additional, easy to use, secure payment channel, via the customers own mobile or online banking service, without the need to share personal information or card data,” a release added.
“CDER Group will use this platform to receive direct payments from customers with every transaction authorised by bank level security thus enabling a more secure payment process, further reducing the risk of fraud.”
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