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Debt-Market Slowdown Troubles Investors (#GotBitcoin?)

Recent turbulence in the corporate-bond market is attributed to Fed’s tightening monetary policy and weaker appetite for debt.

Signs of stress are mounting in the corporate-bond market, where rising interest rates and lackluster demand for new debt have investors questioning whether a long run of favorable borrowing conditions for U.S. companies is ending or merely hitting a rough patch.

The amount of extra yield, or spread, that investors demand to hold investment-grade U.S. corporate bonds instead of benchmark U.S. Treasurys in recent days reached its highest level in nearly two years, while spreads on junk-rated bonds hit a 19-month high.

The widening gap comes despite a relative dearth of new bond sales from U.S. companies, a sign that investors’ demand has slowed faster than supply. When businesses have sold debt recently, they have often struggled to attract much interest, giving investors more say over interest rates and other key terms.

One source of stress has come from a sharp drop in oil prices, which exert an especially strong influence on junk bonds because of the large amount of debt issued by speculative-grade energy companies. There have also been company-specific problems that have happened to befall particularly large debt issuers, such as General Electric Co. and PG&E Corp.

Investors and economists closely watch the corporate-debt market because changes in borrowing costs can alter investment decisions and mean the difference between viability and bankruptcy for businesses at the bottom end of the ratings spectrum.

The recent turbulence in the corporate-bond market has largely followed swings in stocks, in contrast to some past episodes. To some investors and analysts, that suggests the latest wave of selling could reflect a temporary shift in investor sentiment, rather than fundamental problems with the economy.

Still, there is little doubt that bonds, like stocks, face challenges. Those start with steadily tightening monetary policy from the Federal Reserve, which has expressed public concern with lofty asset prices.

“Fundamentally, the economy is still in good shape and corporate profits are in good shape, but we just have so many one-off situations… that everybody is looking for the next problem,” said Kenneth Harris, senior portfolio manager at Segall Bryant & Hamill. Mr. Harris has been reducing risk in his bond portfolios throughout the year by buying shorter-term bonds and those with higher credit ratings.

As of Thursday, the average investment-grade corporate bond spread was 1.28 percentage points, up from 0.85 percentage point in February but below the 2.15 level it reached in Feb. 2016, according to Bloomberg Barclays data. The average speculative-grade spread was 4.04 percentage points, compared with 3.03 percentage points in October and 8.39 percentage points in Feb. 2016.

For much of the past decade, analysts have expressed alarm as a prolonged period of low interest rates has encouraged U.S. companies to add large amounts of debt to their balance sheets. Even the lowest-rated borrowers have often been able to issue bonds and loans that featured minimal protections for investors, making the debt riskier even as more of it sloshes around the financial system.

Before traders began selling riskier assets near the start of October, companies had already started to borrow a little less while their earnings rose, leading to some modest improvement in overall corporate leverage ratios.

There are recent hints, however, that the mostly-voluntary slowdown in borrowing could be exacerbated now by a turn in the market, which some worry could spell trouble for the economy.

In the past week, for example, hospital operator LifePoint Health Inc. was forced to make a rash of investor-friendly changes to a nearly $5 billion bond-and-loan package backing its merger with private-equity firm Apollo Global Management -owned RCCH HealthCare Partners.

Several investors expressed concern about the company’s reliance on rural hospitals, which have struggled recently as a result of declining foot-traffic and efforts by insurers to reduce health-care costs. Still, the tone of the market aggravated those concerns. Bonds backing several recent leveraged-buyouts have fallen below par in recent weeks, and that inevitably led to second thoughts about buying the latest such offering, investors said.

After shifting $150 million from the bond portion of the deal to the loan portion, LifePoint ultimately priced $1.425 billion of bonds at par with a 9.75% coupon, up from initial guidance in the 9%-9.25% range. Even so, the bonds immediately fell in the secondary market, trading Friday afternoon at around 98 cents on the dollar for a yield of just over 10%, according to MarketAxess.

The LifePoint deal was notable because it was the largest sale of junk-rated debt since riskier assets started to come under pressure more than a month ago. It came after a few companies, including oil and gas company GEP Haynesville and brokerage firm INTL FCStone Inc., were forced to cancel smaller bond sales in recent weeks.

Attracting demand for sales of debt from highly rated companies hasn’t been as challenging. But it also hasn’t been as easy as it once was. On Wednesday, DowDuPont Inc. was able to sell $12.7 billion of bonds to fund the spinoff of its agriculture and materials units. Still, the chemical company only did so at higher-than-expected yield-premiums – in some cases nearly 0.3 percentage point above what its existing bonds were yielding as they were headed into the sale.

Corporate bond spreads are still far off the highs they reached in early 2016, when U.S. crude oil was trading at roughly half current prices and investors were concerned about the potential for an imminent recession, let alone during the financial crisis. And despite the spread widening, investors said, the debt markets remain far from closed off. In some cases, riskier borrowers have only needed to move from bonds to loans to raise funds, given continued demand for debt with floating interest rates.

Still, the DowDuPont sale was one sign that even investment-grade companies have recently been having a challenging time, said Ron Quigley, managing director and head of fixed-income syndicate at broker-dealer Mischler Financial Group Inc. Another is the 27 investment-grade companies and countries that are known to be waiting to issue bonds, which is an immense amount to have in the pipeline, he added.

DowDuPont bonds have held their ground in the secondary market. A 3.766% note due 2020 was trading at a spread to Treasurys of around 0.8 percentage point Friday, down from 0.9 percentage point at issuance, according to MarketAxess.

Updated 11-20-2018

Aramco Abandons Plan for Massive Corporate-Bond Sales to Fund Sabic Deal

Saudi oil company concerned about disclosure requirements and uncertain outlook for oil prices.

Saudi Aramco no longer plans to launch what would have been one of the world’s largest-ever corporate-bond sales to fund a roughly $70 billion stake in the kingdom’s national petrochemical firm, looking instead to options requiring less public disclosure, people familiar with the matter said.

Saudi Arabian Oil Co., as the company is officially known, had considered issuing up to $40 billion in bonds to help buy 70% of Saudi Basic Industries Corp., The Wall Street Journal has reported.

But people familiar with Aramco’s financing discussions say the oil firm is now worried about the level of disclosure required for a bond issue and whether the uncertain outlook for the oil market might damp demand for debt or increase the cost of borrowing.

Aramco executives also have raised concerns that the recent diplomatic fallout from the murder of Saudi dissident journalist Jamal Khashoggi might affect investors’ appetite for Saudi debt, the people said.

The Saudi government is encouraging Aramco to buy the stake to inject cash into its sovereign-wealth fund, the Public Investment Fund, or PIF, which owns the stake in the petrochemicals firm.

Instead of a bond, Aramco is now looking at a combination of other potential financing options, people familiar with the matter said.

It could organize a syndicated loan with banks and use Sabic’s balance sheet to raise debt to pay for some of the roughly $70 billion cost, the people said. The oil firm also could reduce the amount of cash it pays in royalties to the Saudi finance ministry for public spending and instead transfer money to PIF, or stagger payments from its cash flow to the fund over time, these people added.

Aramco declined to comment. Representatives for PIF and Sabic didn’t immediately respond to requests for comment.

The potential bond sale had excited bankers hoping to win a place arranging the capital raising. JPMorgan and Morgan Stanley are already acting as advisers for Aramco on the Sabic purchase and Goldman Sachs and Bank of America Merrill Lynch are working with PIF, according people familiar with the matter.

The Aramco acquisition of the Sabic stake is expected to infuse PIF with billions of dollars to invest in technology companies and diversify the kingdom’s oil-dependent economy. PIF already has committed $65 billion to two outside funds—one for infrastructure investment managed by Blackstone Group LP and $45 billion for a technology fund led by SoftBank Group . It has also said it would develop new billion-dollar industries in tourism, entertainment and defense.

Proceeds of a roughly $100 billion IPO of Aramco had been earmarked for the sovereign-wealth fund, but that process has since stalled in part because of the level of scrutiny a listing would have brought to Saudi Arabia’s state oil giant.

Although not as detailed as an IPO, a corporate bond sale on international markets typically would require a company to publicly disclose three years of audited financial statements and highlight key risks to operations. Aramco currently doesn’t disclose income statements, and its balance sheet is a black hole for analysts.

Neither Aramco nor Sabic is enthusiastic about the deal, but the two companies have acquiesced under pressure from government officials, The Wall Street Journal has reported, citing people familiar with the matter.

Aramco executives also are now concerned that market conditions aren’t ideal for bond sales.

Oil prices have fallen more than 20% over the past month and a half, dropping most dramatically since the U.S. government exempted hundreds of thousands of barrels a day of Iranian crude from new American sanctions. Saudi Arabia is moving to prop up prices with a production cut, but uncertainty over how much it will cut and whether it will boost prices has clouded the outlook for oil traders and producers.

Aramco executives also have tussled with PIF over the price of Sabic, further complicating the deal. Any agreement below Sabic’s listed market price would inject less capital into the sovereign-wealth fund and likely force down Sabic’s listed shares, hurting minority shareholders, analysts say.

Sabic lists 25% of its shares on the Saudi Stock Exchange and has a market capitalization of roughly $100 billion.

Updated 11-22-2018

Global Selloff Tests Changed Credit Market

The selloff has descended on a market that has both grown enormously and decreased in quality.

Corporate bonds have taken a beating in November, adding to an already difficult year for a market that thrived in an era of ultra-easy money.

Prices have tumbled, sending yields, which move in the opposite direction, to multiyear highs. Yields on dollar bonds issued by Asian corporations reached their highest levels in nearly seven years this week, averaging about 5.67%. U.S. corporate bond yields hit an eight-and-a-half-year peak of 4.38%. And even in Europe, where benchmark interest rates for the eurozone are still negative, yields reached their highest since early 2016.

Much of the move reflects rising yields on Treasury bonds and other government debt, as the Federal Reserve raises U.S. interest rates. The Fed is also reducing its vast holdings of bonds and its counterpart in Frankfurt, the European Central Bank, has said it expects to follow suit.

“Bad news wasn’t absorbed by the market when the Fed and ECB were both buying,” said Han Rijken, head of specialized fixed income at NN Investment Partners. “Now, when those headlines hit, everything gets repriced.”

Spreads, or the extra compensation investors demand for holding comparatively riskier debt, are also increasing, although these premiums are still modest by historical standards. ICE Bank of America Merrill Lynch indexes show yields on bonds with triple-B credit ratings, the lowest scores still considered investment-grade, have risen faster than those on safer debt. The average spread on BBB bonds in that index is now 1.8 percentage points, more than twice as high as for double- or triple-A rated debt.

Credit-default swaps are derivatives that pay out if companies fail to repay investors. They mirror bond spreads, in that they increase in price when investors perceive increasing risks of default. They are stirring, too. CDS indexes in Asia, the U.S. and Europe have all risen to the highest in about a year and a half.

The selloff has descended on a market that has both grown enormously and decreased in quality. BBB-rated bonds now make up almost half of the ICE BAML global corporate bond index, up from about a quarter just a decade ago. The index has doubled in size in that period as issuers around the world took advantage of low interest rates.

The changing composition of the bond universe introduces extra risks for investors tracking the broad market. Lower-rated bonds tend to fall more sharply if sentiment deteriorates, and are more likely to default or be downgraded to junk, which can prompt some forced selling.

General Electric Co. is one high-profile company with a lower investment-grade rating that has struggled. Yields on GE bonds due in 2025 have soared this year to 6.4% from below 3%.

What happens in the corporate bond market has wider implications, since rising credit spreads can feed through to the rest of the economy. Morgan Stanley analysts say a sustained 1 percentage point rise in triple-B credit spreads tightens U.S. financial conditions as much as a 0.6 percentage point interest rate increase.

Still, many investors believe the selloff represents a re-evaluation of the fair price of corporate bonds, now interest rates are higher, rather than fears about weak balance sheets.

Thomas Poullaouec, head of multiasset solutions for Asia Pacific at T. Rowe Price in Hong Kong, said economic statistics suggested this was a relatively benign move. “As long as we see hard and soft data and sentiment indicators are not plunging, this would mean that this is more of a repricing than a crisis looming,” he said.

Similarly, Neeraj Seth, head of Asian credit at BlackRock in Singapore, said he expected defaults to rise but didn’t see any crisis ahead.

The selloff has hit Asian dollar bondholders hardest this year, since the market is threatened not just by rising interest rates from the Fed but also by a rise in Chinese corporate defaults, which were previously anathema to Beijing. So far, these mostly involve onshore securities denominated in yuan, but holders of hard-currency debt are also jumpy.

Rising Rates

The Federal Reserve’s interest rate hikes have raised the cost of debt issuance for companies borrowing indollars around the world.

Another source of pressure on prices: Chinese issuers themselves. Many held off selling new debt as trade tensions escalated. But they can no longer postpone refinancing existing debt, and now have to offer juicier yields to entice investors.

“What we’re seeing right now is this sudden renewal of supply,” said Karan Talwar, an emerging-market fixed income investment specialist at BNP Paribas Asset Management.

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Your questions and comments are greatly appreciated.

Monty H. & Carolyn A.

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