“Deals Resume in Sale of Risky Loan Funds” The WSJ, Tuesday June 30, 2020, B9.
CLO sales cross $34 billion YTD, $5 billion in June alone as investors re-enter the risky loans market. The Fed’s corporate debt buying program is catalyzing U.S. investor appetite seeking higher spreads ( AAA at LIBOR+1.65) , even as Japanese institutional investors curtail risk taking and have been pulling back.
In 2020 CLO investors need to be especially hands-on to understand the origination processes, servicers, borrowers and quality of underlying collateral. Quality and performance of the underlying collateral is worsening materially more than expected, suggesting that the underwriting process did not consider severity of coronacrisis induced slowdown. In many cases originators had created loans primarily for sale and retained little, if any, interest in ongoing performance. Investors also need to get more deeply involved in the information cycle where excessive reliance on lagging ratings doesn’t help. In the 2008 global financial crisis default and delinquency data was artificially low because of extend and pretend and refinancing. Reliance on historical performance data and statistical models and stress test is insufficient. Investors need to manage the risk that their models are becoming irrelevant to changing conditions in the underlying loans space.
#ActiveAllocator Research – Companies are likely to become vulnerable to activist investors during the coronacrisis period. To explain transaction mechanics, activist hedge fund motives and criteria, we analyzed 15 Icahn transactions over the years. We present these in succinct case studies each day on our research blog.
Also, you can derive your own optimal portfolio allocation to activist and other hedge fund strategies on activeallocator.com
Wall Street Journal, June 29, B1 article “Debt From American Companies Lures Asian, European Investors”.
U.S. corporate debt now much riskier as default rates rise, but Asian and European investor demand is very high. Fed backstop expectations prompts switch from holding low yielding treasuries to higher yielding corporate debt.
This week’s large banks stress tests by the Federal Reserve project losses in pronounced downturn at $700 billion. This scenario is likely in the event of a widespread and prolonged economic downturn.
Are we headed into one with attendant risks of a financial crisis? Looks unlikely. I examined financial crisis over the last 3 decades and was quite unable to come up with common root causes that trigger these events – necessitating different tools each time . Here is a visual I update that speaks to this.
The Wall Street Journal Fri, June 26, 2020 reports Federal Reserve writedown estimations after it conducts stress tests on leading banks. It orders banks to cap dividends and suspend share buy backs.
We contrast June, 2020 write down estimations with reconstructed numbers from October 2008 estimations. Federal Reserve stress tests June 2020 project large bank losses in pronounced downturn at $700 billion on soured loans and writedowns. In 2008 this loss was estimated at double the amount, suggesting that the global financial crisis was twice as severe as far as the banking sector is concerned.
ActiveAllocator Research – Companies are likely to become vulnerable to activist investors during the coronacrisis period. To explain transaction mechanics, activist hedge fund motives and criteria, we analyzed 15 Icahn transactions over the years. We present these in succinct case studies each day on our research blog.
Also, you can derive your own optimal portfolio allocation to activist and other hedge fund strategies on activeallocator.com.
WSJ June 24, 2020 article “AbuDhabi Gets $10 Billion Deal”
We see this infrastructure deal as midstream transportation and hydrocarbon handling and transportation. It is a typical gas pipeline deal that uses a “toll-road” or “fee-for-service” business model to handle, process, and trans-port oil, gas, gas liquids, and refined products.
As coronacrisis progresses expect companies to separate portions of business. Such actions will be typically driven by strategic decisions to divest businesses and/or valuation creation opportunities. Often there is a valuation drag on due to ownership of lower valuation businesses. Spin-offs often have potential for shareholder value creation when investors have higher valuation expectations of the new separate public company.
ActiveAllocator Research – Re. WSJ Wed, June 24, 2020, A1 article ‘Dell Explores Spinning Off $50 Billion VMware Stake”. I see at least three options for Dell – an outright spin-off, a carveout, or a total sale. All of these will unlock Dell’s $50 billion, 81% VMware stake, boost stock-price which has been near static while tech indices have surged past year, and reduce its debt burden. We have a fair bit of experience in the investment banking space and I will keep you posted as the deal progresses.
#ActiveAllocator Research – WSJ Wed, June 17, 2020, B11 today has a piece “Construction Shares Leap Amid Optimism On Infrastructure Bill”. While President Trump has long called on Congress to allocate big to infrastructure in coronavirus aid relief packages we remain pessimistic that such a bill will be passed in 2020. Infrastructure as a sector can absorb huge amounts of capital, can facilitate the growth of businesses, promote trade and enhances economic welfare by improving access to vital resources.
The VIX has been very high last few months and at 35 today. Some talking heads on CNBC have been suggesting that this is the time to buy momentum given elevated volatility. I tested the data and find no relationship between past volatility and near-term future returns. I do find volatility clustering effects, which is very high, but this in itself is non-sequitur to a suggestion for entering into equity momentum trades.
Historical volatility measures can forecast future volatility, albeit with some error. Volatility clusters when periods of high volatility followed by periods of high volatility, and periods of low volatility tend to be followed by periods of low volatility. We also tested with VIX, a forward- looking measure, to find materially similar outcome. Constant volatility exposure can be arrived by de-leveraging when past volatility was high and leveraging when past volatility was low. No relationship between past volatility and near-term future returns.
ActiveAllocator Research – Response to WSJ , June 13, 2020 “Investors Bet on Volatility Making Markets Even Wilder”. I read and decided to test for the relationship between volatility and equity markets and credit ratings. Prelim results suggest that VIX is negatively correlated to equity indices, positively correlated to credit, predicts and serves as a leading indicator and reacts quickly when uncertainty increases.
“Investors Bet on Volatility Making Markets Even Wilder” WSJ , June 13, 2020
With investors increasingly focused on volatility trades the VIX is now an increasingly popular trading instrument. Trading profitability depends upon market returns, where the VIX futures are trading relative to VIX spot, and the absolute level of the VIX at trade initiation. VIX is negatively correlated to equity indices.
Sectors most punished in Q1 have rebounded most in Q2. Especially energy after oil prices rise and economy opens. Financials and industrial pricing in future growth and consumer discretionary reflects fundamentals. Technology, concentrated in 5 firms, a big part of S&P 500 and likely overvalued.
European Bank for Reconstruction and Development (EBRD) President Suma Chakrabarti has been critical of the U.S. which holds a 10 percent share of the bank’s capital. He says the U.S. has been remiss in leadership role. I agree, and with good reason. The EBRD was set up in 1991 and is now completely irrelevant as far as U.S. national interests go. My private opinion is the U.S. tax payer $ should Not fund Development Banks except upon occasion. I urge withdrawal and de-funding.
Here is quick way to begin to arrive at the share repurchase decision
Response to WSJ, Monday, June 8, 2020, ” Why Many People Misunderstand Dividends, And the Damage This Does”
We agree and opine that with earnings and therefore dividends to remain low, companies should reduce outstanding shares to increase per share price through share buybacks. They ought to return value to shareholders through buybacks rather than dividends and provide investors the option to benefit from continued appreciation and defer taxes by selling shares at later date. We compare and highlight the benefits here.
Direct relationship between share repurchase size and excess returns at announcement. Multiple re-purchasers benefit more from large repurchase announcements. Smaller buyback announcements tend to be anticipated and partially priced in. Market reaction to buyback announcements is the uncertainty about whether the buyback will be executed. Larger repurchase correlated with greater abnormal return.
The New York Times, Tue Jun 2, B3 ” Poor Countries Facing an Unparalleled Debt Crisis”
Once the dust settles, we expect the banks are going to get hit. 77 poor countries scheduled to make $62 billion payments on debts in 2020. While governments will stand behind banks as the Coronacrisis unravels, most banks will be left in a weaker position when this ends. I recommend that banks need to now begin to build capital (and cut balance sheets) from recent levels, take account of an expected increasing level of loan losses, not just from problems emerging to date but from risks of a possible “ credit crunch”, likely over the course of a developing economic down-turn. Here is one scenario how this may play out.
OFC face accusations of being centers of tax-avoidance, money laundering and hot money. Additionally they are also challenged by a variety of regulatory authorities and existing onshore center competition.