Tag Archives: Credit Rating

Is The Corporate Debt Bubble Bursting? GE’s 5% Perpetual Bond Falls To $79 While Stock Goes Sub-$10

Last decade, there was a residential mortgage credit bubble that burst. While there doesn’t appear to be a residential mortgage credit bubble (well, just a little), there is most definitely a corporate debt credit bubble that appears to be bursting.

Take General Electric. Their stock price has slipped to under $10 per share from over $30 per share back in early 2017 while the 5% perpetual bond has rapidly gone from around par ($100) to $79 in the wink of The Fed’s eye.

https://confoundedinterestnet.files.wordpress.com/2018/11/geperp.png

Of course, GE’s earnings-per-share have been tanking as interest rates have been rising.

https://confoundedinterestnet.files.wordpress.com/2018/11/geearn.png

And to make matters worse, US investment grade debt is on track for worst year since 2008.

https://confoundedinterestnet.files.wordpress.com/2018/11/corpbondpain.png

Like Robot Monster, the Federal Reserve has helped to create bubbles in the corporate bond market.

Source: Confounded Interest


“The Collapse Has Begun” – GE Is Now Trading Like Junk

Two weeks after we reported that GE had found itself locked out of the commercial paper market following downgrades that made it ineligible for most money market investors, the pain has continued, and yesterday General Electric lost just over $5bn in market capitalization. While far less than the $49bn wiped out from AAPL the same day, it was arguably the bigger headline grabber.

The shares slumped -6.88% after dropping as much as -10% at the lows after the company’s CEO, in an interview with CNBC yesterday, failed to reassure market fears about a weakening financial position. The CEO suggested that the company will now urgently sell assets to address leverage and its precarious liquidity situation whereby it will have to rely on revolvers – and the generosity of its banks – now that it is locked out of the commercial paper market.

https://www.zerohedge.com/sites/default/files/inline-images/GE%20CP%20hole.jpg

Indeed, shares hit levels first seen in 1995 yesterday and have only been lower since, very briefly, during the financial crisis when they hit $6.66 in March 2009. For a bit of perspective, Deutsche Bank notes that the market cap of GE now is $69.5bn and it’s the 80th largest company in the S&P 500. Yet in August 2003, GE was the largest company in the index (and regularly the world between 1993-2005) at a market cap of $296bn, $12bn more than Microsoft in second place. Since then, the tech giant has grown to be a $826bn company well over 10 times the size, while GE’s market cap peaked (ironically) during the dot com bubble in August 2000 at $594BN before tumbling first in the tech crash and then the GFC.

But while most investors have been focusing on GE’s sliding equity, the bigger concern is what happens to the company’s giant debt load, especially if it is downgraded to junk.

First, some background: GE had about $115 billion of debt outstanding as of the end of September, down from $136 billion a year earlier. And while GE is targeting a net EBITDA leverage ratio of 2.5x, this hasn’t been enough to appease credit raters, which have expressed concern recently that GE’s beleaguered power business and deteriorating cash flows will continue to weaken the company’s financial position. As a result, Moody’s downgraded GE two levels last month to Baa1, three steps above speculative grade. S&P Global Ratings and Fitch Ratings assign the company an equivalent BBB+, all with stable outlooks.

The problem is that while the rating agencies still hold GE as an investment grade company, the market disagrees.

GE – a top 15 issuer in both the US and EU indices – was recently downgraded into the BBB bucket, and as recently as September it was trading 20bps inside BBB- bonds. However they crossed over at the end of that month and now trade up to 50bps wide to the average of the weakest notch of IG.

https://www.zerohedge.com/sites/default/files/inline-images/GE%20vs%20BBB.png?itok=NBrvx6Au

In other words, GE is already trading like junk, and has become the proverbial canary in the coalmine for what many have said could be the biggest risk facing the bond market: over $1 trillion in potential “fallen angel” debt, or investment grade names that end up being downgraded to high yield, resulting in a junk bond crisis.

As Deutsche Bank’s Jim Reid notes, GE’s recent collapse has come at time when much discussion in recent months has been about BBBs as a percentage of the size of the HY market. Since 2005, BBBs have been steadily rising as a percentage of HY climbing back above the previous peak in 2014 (175%) before extending that growth to a current level of 274%. Meanwhile, the total notional of BBB investment grade debt has grown to $2.5 trillion in par value today, a 227% increase since 2009, and now represents 50% of the entire IG index. 

https://www.zerohedge.com/sites/default/files/inline-images/BBB%20as%20percentage%20of%20total%20debt.jpg?itok=PQMc5UWr

Next, to get a sense of just how large the risk of fallen angels in the US is, consider that the BBB part of the IG index is now ~2.5x as large as the entire HY index.

https://www.zerohedge.com/sites/default/files/inline-images/BBB%20par%20vs%20HY%20par.jpg

So large BBB companies – and none are larger than GE – with a deteriorating credit story are prone to additional widening pressure as investors fear the risks of an eventual downgrade to HY and a swamping of paper into that market. This, as Deutsche Bank writes, isn’t helping GE at the moment and may be a dress rehearsal for what happens for weaker and large BBB issuers in the next recession.

Meanwhile, while GE is not trading as a pure play junk bond just yet, it is well on its way as the following chart of GE’s spread in the context of both IG and HY shows.

https://www.zerohedge.com/sites/default/files/inline-images/GE%20spread%20IG%20vs%20HY.jpg?itok=xpv-KlGJ

Which is both sad, and ironic: as Bloomberg’s Sebastian Boyd writes this morning, “the company’s CEOs boasted of its AAA rating as a key strategic asset, but it was more than that. The rating, which it maintained for more than half a century, was symbolic of the company’s status as a champion of American commerce. Now, Microsoft and Johnson & Johnson are the only U.S. corporates with the top rating from S&P.”

And while rating agencies have yet to indicate they are contemplating further cuts to the company’s investment grade rating, the bond market has clearly awoken, and nowhere more so than in the swap space, where GE’s Credit Default Swaps have exploded in recent weeks.

https://www.zerohedge.com/sites/default/files/inline-images/2018-11-13%20%282%29.png?itok=0F9w25ah

What kind of an impact would GE’s downgrade have? With $48 billion of bonds in the Bloomberg Barclays US Corporate index, GE would become almost 9% of the BB universe. And one look at Boyd’s chart below shows that the market is increasingly pricing GE’s index-eligible bonds as junk, especially in the context of the move over the past month.

https://www.zerohedge.com/sites/default/files/inline-images/GE%20bonds%20vs%20BB%2B.jpg?itok=opTII-vm

An additional risk to the company’s credit profile: GE has more debt coming due in the next 18 months than any other BBB rated borrower: that fact alone makes it the most exposed to higher rates according to Boyd.

Meanwhile, GE’s ongoing spread blow out, and junk-equivalent price, has not escaped unnoticed, and as we have been warning for a while, could portend a broader repricing in the credit sector. As Guggenheim CIO commented this morning, “the selloff in GE is not an isolated event. More investment grade credits to follow. The slide and collapse in investment grade debt has begun.”

Then again, Minerd’s concern pales in comparison to what some other credit strategists. In an interview with Bloomberg TV on November 8, Bruce Richards, chairman and chief executive officer of the multi-billion Marathon Asset Management warned that over leveraged companies “are going to get crushed” in the next recession.  Richards also warned that when the cycle does turn, “with no liquidity in the high-yield market to speak of, when these tens of billions or potentially hundreds of billions falls into junk land, it’s “Watch out below!” because there’s going to be enormous price adjustments.”

Echoing what we said above, Richards noted that about $1 trillion of bonds are rated as BBB, as investment- grade, when they has leverage ratios worthy of junk, adding that “the magnifying glass is now shifting” toward ratings companies.

For now the “magnifying glass” appears to have focused on GE, and judging by the blow out in spreads for this “investment grade” credit, what it has found has been unexpected. Which brings us to the question we asked at the top: will GE be the canary in the credit crisis coalmine and, when the next crisis finally does strike, the biggest fallen angel of them all?

Source: ZeroHedge

***

“There Is No Corner To Hide”: $100 Billion Fund Manager Warns Credit Rout Is Just Starting

Without that central bank support and transitioning off the fiscal stimulus, our long-term outlook for investment grade is definitely on the more bearish side over the last two to three years.”

Update: The FBI Is Looking Into American Realty Capital Properties

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About: American Realty Capital Properties Inc (ARCP)  by Albert Alfonso

Summary:

  • According to a Reuters report, the FBI has opened a criminal probe of American Realty Capital Properties.
  • This follows the disclosure of accounting errors by the company.
  • This investigation is in addition to a SEC inquiry.

American Realty Capital Properties (NASDAQ:ARCP) just cannot catch a break. Reuters reported that the Federal Bureau of Investigation has opened a criminal investigation into ARCP, according to their sources. The FBI is conducting the investigation along with prosecutors from U.S. Attorney Preet Bharara’s office in New York, according to the Reuters report.

This news comes just days after the company announced a series of accounting errors which had been intentionally not corrected and thus concealed from the public. The amount of money involved, roughly $9.24 million GAAP and $13.60 million AFFO, was relatively small. However, these accounting errors resulted in the resignation of two senior executives, chief financial officer, Brian Block, and chief accounting officer, Lisa McAlister.

Shares of ARCP were trading for as low as $7.85 each on Wednesday, before recovering to $10 per share after CEO David Kay held fairly well received conference call explaining what happened. In the call, Mr. Kay stressed that ARCP’s key metrics were sound. He reaffirmed that the dividend policy will not change, noting that the operating metrics were not impacted and that the NAV is unchanged at $13.25. Nevertheless, the stock continued to fall, closing the week at below $9 per share. In total, ARCP’s stock has fallen 30% since news of the accounting errors first arose, wiping out $4 billion in market value.

Conclusion:

This is quite the shocking development. Not only is the FBI looking into ARCP, but also the Securities and Exchange Commission, which announced its own investigation of the accounting errors late last week. Furthermore, the company was placed on CreditWatch with negative implications by S&P, which risks putting the credit rating into junk territory.

As I noted in my earlier article, accounting issues equal an automatic sell in my book. I sold most of my ARCP holdings on Wednesday, though I still kept some shares, opting instead to sell calls on the remaining position. I now lament that choice as I fear the stock can fall further. An FBI criminal probe is no small matter and represents a clear material risk. What an absolute disaster.

Update: American Realty Capital Properties: The Turmoil Is Only Getting Worse

by Achilles Research

Summary

  • ARCP sent shock waves through the analyst community last week after the REIT said its financials should no longer be relied upon and said goodbye to the CFO and CAO.
  • ARCP is now also attracting heat from the FBI.
  • In addition, RCS Capital Corporation cancels Cole Capital transaction.

Investors in American Realty Capital Properties (NASDAQ:ARCP) need to demonstrate that they have nerves of steel at the moment. After the company reported that it overstated its AFFO last week, and that its Chief Financial Officer and Chief Accounting Officer departed as a result of the accounting scandal, more bad news are seeing the light of day.

First of all, as various news outlets reported, the Federal Bureau of Investigation is putting up some additional heat on ARCP. As Reuters reported:

(Reuters) – U.S. authorities have opened a criminal probe of American Realty Capital Properties in the wake of the real estate investment trust’s disclosure that it had uncovered accounting errors, two sources familiar with the matter said on Friday.

The Federal Bureau of Investigation is conducting the investigation along with prosecutors from U.S. Attorney Preet Bharara’s office in New York, the sources said. Further details of the probe could not be learned.

The involvement of the New York U.S. Attorney’s office is particularly bad news as Preet Bharara takes a tough stance with companies that break the law or push its limits too far. While the criminal probe certainly is bad news and comes in addition to the involvement of the SEC, something else caused massive irritation among ARCP shareholders today: The Cole Capital deal with RCS Capital Corporation (NYSE: RCAP) is in real danger.

According to ARCP’s latest (and angry) press release:

In the middle of the night, we received a letter from RCS Capital Corporation purporting to terminate the equity purchase agreement, dated September 30, 2014, between RCS and an affiliate of ARCP. As we informed RCS orally and in writing over the weekend, RCS has no right and there is absolutely no basis for RCS to terminate the agreement. Therefore, RCS’s attempt to terminate the agreement constitutes a breach of the agreement. In addition, we believe that RCS’s unilateral public announcement is a violation of its agreement with ARCP. The independent members of the ARCP Board of Directors and ARCP management are evaluating all alternatives under the agreement and with respect to the Cole Capital® business, generally. ARCP management and the independent members of the ARCP Board of Directors are committed to doing what is in the best interests of ARCP stockholders and its business, including Cole Capital.

That’s right. Since the FBI now has its fingers in the pie, and the SEC, management at RCS Capital has informed ARCP that it is terminating the deal. Whatever side you are one, you’ve got to admit: American Realty Capital Properties is just falling apart.

The once mighty real estate investment trust has lost a staggering 36% of its market capitalization since shares closed at $12.38 on October 28, 2014, which is a tough pill to swallow for those investors who pledged allegiance to American Realty Capital Properties, despite the turbulence that erupted a week ago.

Technical picture
Shares of American Realty Capital Properties are trading extremely weakly today in light of the new information, and I continue to see further downside potential for this REIT in the near term.

It seems as if all the forces of the universe are conspiring to bring American Realty Capital Properties down to its knees, and an investment in this REIT is not recommendable at the moment.

Source: StockCharts.com

Bottom Line:
The American Realty Capital Properties’ story has gotten significantly worse today: In addition to two of the most important executives abruptly leaving the company amid an accounting scandal, the SEC and the FBI are investigating the company, lawyers are very likely going to hit ARCP with litigation, and the latest transaction is in the process of collapsing.

Bulls must either have nerves of steel or clinging to hope. In any case, ARCP’s prospects have gotten much worse today, and I continue to expect further downside potential driven by litigation concerns, potential fines and extremely negative investor sentiment.

American Realty Capital Comes Clean, And I Feel Dirty

by Adam Aloisi

Summary:

  • American Realty Capital’s restatement has created rampant volatility in a stock already under the gun.
  • Why I decided to sell half of my position in the company.
  • Important portfolio takeaways for investors of all kinds.

This is one of the tougher articles I’ve written for Seeking Alpha. Asset allocation and portfolio strategy for income investors has been my focal point of writing over the past three years. I’ve always been of the opinion that talking about how to fish trumps simply giving someone fish to chew on.

Still, I mention equity-income stocks all the time in articles, but it’s rare that I write focus articles. On October third, I wrote, “American Realty Capital Properties: 30% Total Return Next Year“. Less than a month later, I find that post in an inverse position, with American Realty Capital (NASDAQ:ARCP) having dropped around 30% in market value.

First, I will tell readers that I sold a bit more than half of my position as a result of ARCP’s restatement, and still retain shares. However, it is now one of my smallest income portfolio positions and one that I have lost a majority of my conviction in. ARCP, in my mind, has transitioned from being a higher-risk investment into now becoming day-trader fodder, and at least for the near term, highly speculative. I would have been all over this thing during my trading days, but having become more conservative today with less portfolio churn, it has little room in my portfolio.

I considered all options here. I thought about increasing my position, extinguishing it altogether, selling put options at attractive premiums, or potentially doing nothing. Being so supportive of this story over the past year, I was mostly disappointed that I had to put any thought into the matter at all. For a variety of reasons, I came to the conclusion that halving the position — taking a loss, which I needed to do anyway for taxes — was a prudent near-term choice. I will revisit the decision in a month, and could conceivably buy back those shares once wash sale rules have passed.

Though selling during a period of fear and volatility is not typically in my playbook, following this restatement, I have lost confidence in this story. If you follow me, you know that I certainly identified the elevated risk that ARCP brought to real estate investors. Over the past six months, here are some comments that I made in regard to ARCP in several articles:

If you invest in ARCP today, you should expect the unexpected.

Given all the deals and potential for a misstep, there is heightened risk in owning ARCP.

But with the baggage it continues to drag along with it…..it may not necessarily be appropriate for more conservative investors

I do not consider the stock a table pounding buy.

I even compared Nick Schorsch to Monty Hall from “Let’s Make A Deal,” following the Red Lobster purchase and flip-flop on the strip mall IPO-then-sale.

As the year wore on, however, my convictions rose, since the company did not materially change its guidance to investors, despite all the acquisition activity. I figured if there were a stumble, it would have been disclosed earlier this year as the various acquisitions had time to be absorbed into operations.

While there was much criticism over the Cole quasi-divestiture to RCS and lowered guidance, I remained resolute, thinking there wasn’t another buyer, and this at least got Cole out from under the ARCP umbrella.

Of course as we now know, some financial disclosures were not to be relied upon and guidance should have been changed. If there were not so much other controversy with regard to this company, I doubt the stock would have tanked as much as it has. When you have a managerial crisis of confidence already in place and make a restatement announcement, you create panic. If we take this on face value, it does not appear to be a huge restatement, but taken in totality, this is a monumental, perhaps insurmountable, credibility problem. It’s now all aboard for the ambulance-chasing lawyers.

At this point I have decided that it is in my best interest to rip the towel in half and throw it in. I see it as a hedge against further deterioration in this story that I would not necessarily rule out given the loose management style that I and every ARCP investor knew existed.

We’re not talking about some low level accounting bean counter or paper pusher that seems to have perpetrated this; we’re talking about CFO Brian Block, assumedly someone that David Kay and Nick Schorsch had drinks with regularly. So when Kay defended the culture at ARCP on the conference call by uttering, “We don’t have bad people, we had some bad judgment there,” forgive me if I now wonder if he really has a clue how good, sweet, and honest his executives and rank-and-file workers really are. Although the restatements appear isolated to this year’s AFFO, we’ll have to see if anything turns up in 2013. While I’d like to give this company the benefit of the doubt once again, I’m finding myself staring at a slippery slope of hope that another shoe will not drop.

Still, I did not jettison the entire position because these are emotional times, and the glass-is-half-full part of me says the market is overreacting. We are, keep in mind, still talking about a high-quality portfolio of real estate, not a biotech company whose sole drug was deemed inefficacious by the FDA. In the end, however, I had to make a decision for my own portfolio that I deemed appropriate. This was it.

Meanwhile, I would not criticize nor blame someone for selling out here and moving on to more stable pastures. Fellow REIT writer Brad Thomas apparently has. On the flip side, I could see the more adventurous or those with continued conviction buying in now or upping exposure. The “right” thing to do for many investors may be to simply hold through the volatility. As I opined in a past article on ARCP:

But with the considerable sentiment overhang and “show me” attitude of the market, it could take some time and a strong stomach to see it through.

The sentiment “overhang” has basically become something much worse. And at this point I wouldn’t even want to predict how much time it could take for a rebound. Your stomach constitution will need to be stronger than I first suspected.

Portfolio Takeaways

I’ve had more than one reader tell me that the various risks I identified made them conclude that ARCP was not a stock they should own. And given what has happened here, at least for the near-term, that was obviously a prudent decision. We must all come to personal conclusions as to how much risk we are willing to take to attain income and capital growth goals.

For investors of all types, the most important thing to take away from this near-term “disaster” is that diversification and limiting position size is critical. If ARCP amounted to a couple of percent, or less, of a portfolio, the stock’s tank may not be all that impacting. If it was a more concentrated portion of the overall pie, it becomes a more painful near-term event and makes various portfolio maneuver decisions more challenging to come to.

In the end, portfolio management is a personal endeavor that amounts to an inexact science. Whether you think what I’ve done with my ARCP position is right or not is not really all important. The more important thing is whether you are comfortable with the personal portfolio decisions you make or not, why you make them, and whether they are right for your situation.

I’ve used the word “I” more than I normally would in an article. This one was indeed about me and owning up to putting wholesale trust in a management team that apparently I shouldn’t have. And it was a about a decision I really didn’t want to make as a result. Unfortunately, we have to take the bad with the good in the investment world, brush ourselves off, move on, and continue to make personal decisions that are right for our portfolios.